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Optimal fiscal and monetary policy under imperfect competition

  • Schmitt-Grohe, Stephanie
  • Uribe, Martin

This paper studies optimal fiscal and monetary policy under imperfect competition in a stochastic, flexible-price, production economy without capital. It shows analytically that in this economy the nominal interest rate acts as an indirect tax on monopoly profits. Unless the social planner has access to a direct 100 percent tax on profits, he will always find it optimal to deviate from the Friedman rule by setting a positive and time-varying nominal interest rate. The dynamic properties of the Ramsey allocation are characterized numerically. As in the perfectly competitive case, the labor income tax is remarkably smooth, whereas inflation is highly volatile and serially uncorrelated. An exact numerical solution method to the Ramsey conditions is proposed.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 26 (2004)
Issue (Month): 2 (June)
Pages: 183-209

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Handle: RePEc:eee:jmacro:v:26:y:2004:i:2:p:183-209
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622617

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  1. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-83, April.
  2. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
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  11. 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.
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  13. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
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  16. Guidotti, Pablo E. & Vegh, Carlos A., 1993. "The optimal inflation tax when money reduces transactions costs : A reconsideration," Journal of Monetary Economics, Elsevier, vol. 31(2), pages 189-205, April.
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