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Optimal Fiscal and Monetary Policy Without Commitment

  • Stefan Niemann

    ()

  • Paul Pichler

    ()

  • Gerhard Sorger

    ()

This paper studies optimal fiscal and monetary policy in a stochastic economy with imperfectly competitive product markets and a discretionary government. We find that, in the flexible price economy, optimal time-consistent policy implements the Friedman rule independently of the degree of imperfect competition. This result is in contrast to the Ramsey literature, where the Friedman rule emerges as the optimal policy only if markets are perfectly competitive. Second, once nominal rigidities are introduced, the Friedman rule ceases to be optimal, inflation rates are low and stable, and tax rates are relatively volatile. Finally, optimal time-consistent policy under sticky prices does not generate the near-random walk behavior of taxes and real debt that can be observed under optimal policy in the Ramsey problem. A common reason for these results is that the discretionary government, in an effort to asymptotically eliminate its time-consistency problem, accumulates a large net asset position such that it can finance its expenditures via the associated interest earnings.

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Paper provided by University of Essex, Department of Economics in its series Economics Discussion Papers with number 654.

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Date of creation: 16 Jun 2008
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Handle: RePEc:esx:essedp:654
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  1. Ramon Marimon & Javier Díaz-Giménez & Giorgia Giovannetti & Pedro Teles, 2007. "Nominal Debt as a Burden on Monetary Policy," NBER Working Papers 13677, National Bureau of Economic Research, Inc.
  2. Salvador Ortigueira & Joana Pereira & Paul Pichler, 2012. "Markov-perfect optimal fiscal policy : the case of unbalanced budgets," Economics Working Papers we1230, Universidad Carlos III, Departamento de Economía.
  3. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimality of the Friedman Rule in Economies with Distorting Taxes," NBER Working Papers 4443, National Bureau of Economic Research, Inc.
  4. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
  5. Paul Klein & Per Krusell & José-V�ctor R�os-Rull, 2008. "Time-Consistent Public Policy," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 789-808.
  6. repec:bla:restud:v:75:y:2008:i:3:p:789-808 is not listed on IDEAS
  7. Klein Paul & Quadrini Vincenzo & Rios-Rull Jose-Victor, 2005. "Optimal Time-Consistent Taxation with International Mobility Of Capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-36, June.
  8. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June.
  9. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  10. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  11. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
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