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Optimal Monetary Policy When Lump-Sum Taxes Are Unavailable: A Reconsideration of the Outcomes under Commitment and Discretion

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  • Martin Ellison

    ()

  • Neil Rankin

    ()

Abstract

We re-examine optimal monetary policy when lump-sum taxes are unavailable. Under commitment, we show that, with alternative utility functions to that considered in Nicolini’s related analysis, the direction of the incentive to cheat may depend on the initial level of government debt, with low debt creating an incentive towards surprise deflation, but high debt the reverse. Under discretion, we show that the economy will not necessarily tend to the Friedman Rule, as Obstfeld found. Instead it may tend to the critical debt level at which there is no cheating incentive under commitment, and inflation and could well be positive here.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Conference Paper Series with number 0501.

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Date of creation: Aug 2005
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Handle: RePEc:san:cdmacp:0501

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Keywords: Time consistency; optimal inflation-tax smoothing; discretion; commitment; Friedman Rule.;

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  1. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, American Economic Association, vol. 73(5), pages 871-80, December.
  2. Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2000. "Nominal Debt as a Burden to Monetary Policy," Econometric Society World Congress 2000 Contributed Papers 1387, Econometric Society.
  3. Rotemberg, Julio J, 1984. "A Monetary Equilibrium Model with Transactions Costs," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 92(1), pages 40-58, February.
  4. Herrendorf, Berthold, 1997. " Time Consistent Collection of Optimal Seigniorage: A Unifying Framework," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 11(1), pages 1-46, March.
  5. Maurice Obstfeld, 1989. "Dynamic Seigniorage Theory: An Exploration," NBER Working Papers 2869, National Bureau of Economic Research, Inc.
  6. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(3), pages 335-359.
  7. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(5), pages 919-44, October.
  8. Obstfeld, Maurice, 1991. "A model of currency depreciation and the debt-inflation spiral," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 15(1), pages 151-177.
  9. Neiss, Katharine S, 1999. "Discretionary Inflation in a General Equilibrium Model," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 31(3), pages 357-74, August.
  10. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 55-93.
  11. Nicolini, Juan Pablo, 1998. "More on the time consistency of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 41(2), pages 333-350, April.
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