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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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