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Optimal Fiscal and Monetary Policy: Equivalence Results

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  • Isabel Horta Correia
  • Juan Pablo Nicolini
  • Pedro Teles

Abstract

In this paper, we analyze the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be financed with distortionary taxes. We show that the sets of (frontier) implementable allocations are the same independently of the degree of price stickiness. Furthermore, the sets of policies that decentralize each allocation are also the same except in the extreme cases of flexible and sticky prices, where the sets are larger but still include that common set of policies. In this sense we establish an irrelevance or equivalence of environments. We also describe the minimal set of instruments, in the different environments, and thus discuss equivalence and neutrality of fiscal and monetary instruments. In particular we show that state contingent debt is not necessary, provided there are both consumption and labor income taxes.

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Bibliographic Info

Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200303.

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Date of creation: 2003
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Handle: RePEc:ptu:wpaper:w200303

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  1. Peter A. Diamond & J. A. Mirrlees, 1968. "Optimal Taxation and Public Production," Working papers 22, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "A Note on the Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 106(4), pages 860-889, August.
  3. Bernardino Adão & Isabel Horta Correia & Pedro Teles, 2005. "The Monetary Transmission Mechanism: is it Relevant for Policy?," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
  4. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  5. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  7. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 699-713, October.
  8. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Optimal Fiscal and Monetary Policy Under Sticky Prices," NBER Working Papers 9220, National Bureau of Economic Research, Inc.
  9. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  10. Correia, Isabel & Teles, Pedro, 1996. "Is the Friedman rule optimal when money is an intermediate good?," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 223-244, October.
  11. Carlos E. da Costa & Iván Werning, 2008. "On the Optimality of the Friedman Rule with Heterogeneous Agents and Nonlinear Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 82-112, 02.
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  13. Fiorella De Fiore & Pedro Teles, 2002. "The optimal mix of taxes on money, consumption and income," Working Paper Series WP-02-03, Federal Reserve Bank of Chicago.
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  16. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June.
  17. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
  18. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal Fiscal and Monetary Policy: Equivalence Results," Journal of Political Economy, University of Chicago Press, vol. 116(1), pages 141-170, 02.
  19. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 704-23, August.
  20. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
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  22. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  23. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
  24. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  25. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "Price-level and interest-rate targeting in a model with sticky prices," Working Paper 9819, Federal Reserve Bank of Cleveland.
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  1. Más Política Monetaria No Convencional III: Política Fiscal
    by Jesús Fernández-Villaverde in Nada Es Gratis on 2010-09-14 21:46:59
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