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Optimal Monetary and Fiscal Policy in an Economy with Non-Ricardian Agents

  • Michal Horvath

    ()

The optimal policy mix maximizes a quadratic welfare objective which follows from the agents’ utility function and depends only on inflation and output gap volatility. We analyze the optimal response of the economy to a rise in government spending. We find that the optimal economy moves along an analogue of a conventional inflation-output variance frontier, as the population share of non-Ricardian agents rises. We derive simple optimal policy rules for the interest rate and fiscal surplus and analyze the key determinants of optimal policy. We find little evidence that increased government spending would crowd in private consumption in the optimal economy.

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File URL: http://www.st-andrews.ac.uk/economics/CDMA/papers/wp0703.pdf
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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200703.

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Date of creation: 15 Jan 2007
Date of revision: 15 May 2007
Handle: RePEc:san:cdmawp:0703
Contact details of provider: Postal: School of Economics and Finance, University of St. Andrews, Fife KY16 9AL
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Fax: 01334 462444
Web page: http://www.st-andrews.ac.uk/cdma
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  1. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
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  19. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
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