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Targeting inflation and the fiscal balance : what is the optimal policy mix?

  • Marcela Meirelles Aurelio
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    This paper identifies optimal policy rules in the presence of explicit targets for both the inflation rate and public debt. This issue is investigated in the context of a dynamic stochastic general equilibrium model that describes a small open economy with capital accumulation, distortionary taxation and nominal price rigidities. The model is solved using a second-order approximation to the equilibrium conditions. Optimal policy features a strong anti-inflation stance and strict fiscal discipline. Targeting a domestic inflation index - as opposed to CPI - improves welfare because it reduces the inefficiencies that stem from both price stickiness and income taxes.

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    File URL: http://www.kansascityfed.org/Publicat/Reswkpap/PDF/RWP06-07.pdf
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    Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 06-07.

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    Date of creation: 2006
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    Handle: RePEc:fip:fedkrw:rwp06-07
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    7. Douglas Laxton & Paolo Pesenti, 2003. "Monetary Rules for Small, Open, Emerging Economies," NBER Working Papers 9568, National Bureau of Economic Research, Inc.
    8. Robert Kollmann, 2002. "Monetary policy rules in the open economy: effects of welfare and business cycles," ULB Institutional Repository 2013/7628, ULB -- Universite Libre de Bruxelles.
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    22. Leith, Campbell & Wren-Lewis, Simon, 2000. "Interactions between Monetary and Fiscal Policy Rules," Economic Journal, Royal Economic Society, vol. 110(462), pages C93-108, March.
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    24. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
    25. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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