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Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model

In: NBER Macroeconomics Annual 2005, Volume 20

  • Stephanie Schmitt-Grohé
  • Martín Uribe

In this paper, we study Ramsey-optimal fiscal and monetary policy in a mediumscale model of the U.S. business cycle. The model features a rich array of real and nominal rigidities that have been identified in the recent empirical literature as salient in explaining observed aggregate fluctuations. The main result of the paper is that price stability appears to be a central goal of optimal monetary policy. The optimal rate of inflation under an income tax regime is half a percent per year with a volatility of 1.1 percent. This result is surprising given that the model features a number of frictions that in isolation would call for a volatile rate of inflation—particularly nonstate-contingent nominal public debt, no lump-sum taxes, and sticky wages. Under an income-tax regime, the optimal income tax rate is quite stable, with a mean of 30 percent and a standard deviation of 1.1 percent. JEL Classification: E52, E61, E63

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This chapter was published in:
  • Mark Gertler & Kenneth Rogoff, 2006. "NBER Macroeconomics Annual 2005, Volume 20," NBER Books, National Bureau of Economic Research, Inc, number gert06-1, July.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 0074.
    Handle: RePEc:nbr:nberch:0074
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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    25. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
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