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Optimal Monetary and Fiscal Policy in an Economy with Non-Ricardian Agents

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  • Michal Horvath

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Abstract

The optimal policy mix maximizes a quadratic welfare objective which follows from the agents’ utility function and depends only on inflation and output gap volatility. We analyze the optimal response of the economy to a rise in government spending. We find that the optimal economy moves along an analogue of a conventional inflation-output variance frontier, as the population share of non-Ricardian agents rises. We derive simple optimal policy rules for the interest rate and fiscal surplus and analyze the key determinants of optimal policy. We find little evidence that increased government spending would crowd in private consumption in the optimal economy.

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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200703.

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Date of creation: 15 Jan 2007
Date of revision: 15 May 2007
Handle: RePEc:san:cdmawp:0703

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Keywords: Optimal Monetary and Fiscal Policy; Macroeconomic Stabilization; Non-Ricardian Agents.;

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