Advanced Search
MyIDEAS: Login to save this paper or follow this series

Optimal Fiscal and Monetary Policy when Money is Essential

Contents:

Author Info

  • Sanjay K. Chugh

    (Board of Governors of the Federal Reserve System)

  • S. Boragan Aruoba

    (University of Maryland)

Abstract

We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. Our main results are in stark contrast to the prescriptions of earlier flexible-price Ramsey models. Two especially important findings emerge from our work: the Friedman Rule is typically not optimal and inflation is stable over time. Inflation is not a substitute instrument for a missing tax, as is sometimes the case in standard Ramsey models. Rather, the inflation tax is exactly the right tax to use because the use of money has a rent associated with it. Regarding the optimal dynamic policy, realized (ex-post) inflation is quite stable over time, in contrast to the very volatile ex-post inflation rates that arise in standard flexible-price Ramsey models. We also find that because capital is underaccumulated, optimal policy includes a subsidy on capital income. Taken together, these findings turn conventional wisdom from traditional Ramsey monetary models on its head.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.economicdynamics.org/meetpapers/2007/paper_80.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 80.

as in new window
Length:
Date of creation: 2007
Date of revision:
Handle: RePEc:red:sed007:80

Contact details of provider:
Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-314-444-8731
Email:
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC

Related research

Keywords:

Other versions of this item:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
  2. S. Boragan Aruoba & Randall Wright, 2002. "Search, money and capital: a neoclassical dichotomy," Working Paper 0208, Federal Reserve Bank of Cleveland.
  3. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy under Imperfect Competition," Departmental Working Papers 200101, Rutgers University, Department of Economics.
  4. Faia, Ester, 2009. "Ramsey monetary policy with labor market frictions," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 570-581, May.
  5. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2002. "Optimal Indirect and Capital Taxation," Levine's Working Paper Archive 391749000000000449, David K. Levine.
  6. Narayana R. Kocherlakota, 1996. "Money is memory," Staff Report 218, Federal Reserve Bank of Minneapolis.
  7. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
  8. Joydeep Bhattacharya & Joseph H. Haslag & Antoine Martin, 2004. "Heterogeneity, redistribution, and the Friedman rule," Research Working Paper RWP 04-01, Federal Reserve Bank of Kansas City.
  9. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  10. Jones, Larry E. & Manuelli, Rodolfo E. & Rossi, Peter E., 1997. "On the Optimal Taxation of Capital Income," Journal of Economic Theory, Elsevier, vol. 73(1), pages 93-117, March.
  11. Krause, Michael U. & Lubik, Thomas A., 2007. "The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 706-727, April.
  12. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  13. David M. Arseneau & Sanjay K. Chugh, 2007. "Optimal fiscal and monetary policy with costly wage bargaining," International Finance Discussion Papers 893, Board of Governors of the Federal Reserve System (U.S.).
  14. Narayana R. Kocherlakota, 2005. "Optimal monetary policy: what we know and what we don’t know," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Oct, pages 10-19.
  15. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  16. Sanjay K. Chugh, 2006. "Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices," Computing in Economics and Finance 2006 228, Society for Computational Economics.
  17. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 383-462 National Bureau of Economic Research, Inc.
  18. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
  19. Correia, Isabel H., 1996. "Should capital income be taxed in the steady state?," Journal of Public Economics, Elsevier, vol. 60(1), pages 147-151, April.
  20. Fernando Alvarez & Patrick J. Kehoe & Pablo Andrés Neumeyer, 2004. "The Time Consistency of Optimal Monetary and Fiscal Policies," Econometrica, Econometric Society, vol. 72(2), pages 541-567, 03.
  21. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  22. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers 200105, Rutgers University, Department of Economics.
  23. S. Boragan Aruoba & Christopher J. Waller & Randall Wright, 2007. "Money and capital," Working Paper 0714, Federal Reserve Bank of Cleveland.
  24. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
  25. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
  26. Armenter, Roc, 2008. "A note on incomplete factor taxation," Journal of Public Economics, Elsevier, vol. 92(10-11), pages 2275-2281, October.
  27. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
  28. Randall Wright & Guillame Rocheteau, 2003. "Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search Equilibrium," Levine's Bibliography 666156000000000302, UCLA Department of Economics.
  29. Aleksander Berentsen & Cyril Monet, 2006. "Monetary Policy in a Channel System," IEW - Working Papers 295, Institute for Empirical Research in Economics - University of Zurich.
  30. Ricardo J. Caballero, 2007. "Specificity and the Macroeconomics of Restructuring," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262033623, December.
  31. Allen Head & Alok Kumar, 2005. "Price Dispersion, Inflation, And Welfare," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 533-572, 05.
  32. Walsh, Carl E., 2003. "Labor Market Search, Sticky Prices, and Interest Rate Policies," Santa Cruz Center for International Economics, Working Paper Series qt6tg550dv, Center for International Economics, UC Santa Cruz.
  33. Chugh, Sanjay K., 2007. "Optimal inflation persistence: Ramsey taxation with capital and habits," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1809-1836, September.
  34. Mats Persson & Torsten Persson & Lars E. O. Svensson, 2006. "Time Consistency of Fiscal and Monetary Policy: A Solution," Econometrica, Econometric Society, vol. 74(1), pages 193-212, 01.
  35. 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.
  36. Boragan Aruoba, S. & Rocheteau, Guillaume & Waller, Christopher, 2007. "Bargaining and the value of money," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2636-2655, November.
  37. Acemoglu, Daron & Shimer, Robert, 1999. "Holdups and Efficiency with Search Frictions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 827-49, November.
  38. Chamley, Christophe, 1981. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 468-96, June.
  39. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
  40. Kiyotaki, Nobuhiro & Wright, Randall, 1993. "A Search-Theoretic Approach to Monetary Economics," American Economic Review, American Economic Association, vol. 83(1), pages 63-77, March.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:red:sed007:80. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.