Targeting inflation and the fiscal balance: what is the optimal policy mix?

Marcela Meirelles Aurelio

No RWP 06-07, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: 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.

Keywords: Inflation (Finance); Prices; Fiscal policy (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-pbe
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