Optimal monetary and fiscal policy: a linear-quadratic approach

Pierpaolo Benigno and Michael Woodford

No 806, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We propose an integrated treatment of the problems of optimal monetary and fiscal policy, for an economy in which prices are sticky (so that the supply-side effects of tax changes are more complex than in standard fiscal analyses) and the only available sources of government revenue are distorting taxes (so that the fiscal consequences of monetary policy must be considered alongside the usual stabilization objectives). Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, in addition to characterizing the optimal dynamic responses to shocks under an optimal policy, we derive policy rules through which the monetary and fiscal authorities may implement the optimal equilibrium. These take the form of optimal targeting rules, specifying an appropriate target criterion for each authority.

Keywords: Monetary policy; Fiscal policy (search for similar items in EconPapers)
Date: 2004
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Citations: View citations in EconPapers (66)

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Related works:
Chapter: Optimal Monetary and Fiscal Policy: A Linear-Quadratic Approach (2004)
Working Paper: Optimal monetary and fiscal policy: a linear-quadratic approach (2004)
Journal Article: Optimal monetary and fiscal policy: a linear-quadratic approach (2003)
Working Paper: Optimal Monetary and Fiscal Policy: A Linear Quadratic Approach (2003)
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