Optimal fiscal and monetary policy with sticky wages and sticky prices

Sanjay Chugh

No 834, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominal riskless debt, and money creation. One main result is that sticky wages alone make price stability optimal in the face of government spending shocks, to a degree quantitatively similar as sticky prices alone. With productivity shocks also present, optimal inflation volatility is higher, but still dampened relative to the fully-flexible economy. Key for our results is an equilibrium restriction between nominal price inflation and nominal wage inflation that holds trivially in a Ramsey model featuring only sticky prices. We also show that the nominal interest rate can be used to indirectly tax the rents of monopolistic labor suppliers. Interestingly, a necessary condition for the ability to use the nominal interest rate for this purpose is positive producer profits. Taken together, our results uncover features of Ramsey fiscal and monetary policy in the presence of labor market imperfections that are widely-believed to be important.

Keywords: Inflation (Finance) - Mathematical models; Monetary policy - Mathematical models; Fiscal policy - Mathematical models (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.federalreserve.gov/pubs/ifdp/2005/834/default.htm (text/html)
http://www.federalreserve.gov/pubs/ifdp/2005/834/ifdp834.pdf (application/pdf)

Related works:
Journal Article: Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices (2006)
Working Paper: Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices (2006)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:834

Access Statistics for this paper

More papers in International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.) Contact information at EDIRC.
Bibliographic data for series maintained by Ryan Wolfslayer ; Keisha Fournillier ().