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Jointly optimal monetary and fiscal policy rules under liquidity constraints

  • Bi, Huixin
  • Kumhof, Michael

We study the welfare properties of an economy where both monetary and fiscal policies follow simple rules, and where a subset of agents is liquidity constrained. The welfare benefits of optimizing the fiscal rule are far larger than those of optimizing the monetary rule. The optimized fiscal rule implements strong automatic stabilizers that primarily stabilize the income of liquidity-constrained agents, rather than output. Transfers targeted to liquidity-constrained agents are the preferred fiscal instrument. The optimized monetary rule exhibits super-inertia and a weak inflation response. Optimized simple rules perform as well as the optimal policy under the timeless perspective.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 33 (2011)
Issue (Month): 3 (September)
Pages: 373-389

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Handle: RePEc:eee:jmacro:v:33:y:2011:i:3:p:373-389
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