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On (Sub) Optimal Monetary Policy Rules under Untied Fiscal Hands

We examine the interplay between monetary and fiscal policies in a context where disturbances to the public deficit process are a primary source of macroeconomic instability. We perform simulations of optimal targeting rules on a sticky-price model `a la Woodford (1997). Our investigation compares the dynamic adjustment path under inflation targeting with that arising from nominal income growth targeting. When fiscal shocks enter the picture, inflation targeting is a superior strategy. In opposition to Jensen (2002)’s results, we show that an inflation targeter is capable of bringing about the required degree of interest rate inertia. This does not occur at the cost of additional nominal instability.

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Paper provided by Stockholm University, Department of Economics in its series Research Papers in Economics with number 2002:17.

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Length: 29 pages
Date of creation: 23 Sep 2002
Date of revision:
Handle: RePEc:hhs:sunrpe:2002_0017
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Department of Economics, Stockholm, S-106 91 Stockholm, Sweden

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Web page: http://www.ne.su.se/
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  1. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
  2. Bennett T. McCallum & Edward Nelson, 1998. "Performance of operational policy rules in an estimated semi-classical structural model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  4. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
  5. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  6. Galí, Jordi & Gertler, Mark, 1999. "Inflation Dynamics: A Structural Economic Analysis," CEPR Discussion Papers 2246, C.E.P.R. Discussion Papers.
  7. Perotti, Roberto, 1996. "Fiscal Consolidation in Europe: Composition Matters," American Economic Review, American Economic Association, vol. 86(2), pages 105-10, May.
  8. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  9. Jensen, Henrik, 1999. "Targeting Nominal Income Growth or Inflation?," CEPR Discussion Papers 2341, C.E.P.R. Discussion Papers.
  10. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  11. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  12. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
  13. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  14. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521104609, Junio.
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