Optimal Monetary and Fiscal Policy in a New Keynesian Model with a Dutch Disease: The Case of Complete Markets

Constantino Hevia, Pablo Neumeyer and Juan Pablo Nicolini

Department of Economics Working Papers from Universidad Torcuato Di Tella

Abstract: We analyze optimal policy in New Keynesian model of a small open economy with access to complete asset markets and Dutch Disease periods, in which terms of trade shocks reallocate resources away from the manufacturing sector. Following the policy debate, we introduce an externality in the manufacturing sector that makes the Dutch disease periods inefficient. We show theoretically that if the government has access to standard taxes that can be made time and state dependent, the optimal monetary policy implies complete price stability. The optimal intervention to deal with the externality in manufacturing is a subsidy. We next assume that taxes do not respond to temporary shocks and study monetary policy as the sole stabilization instrument. Using a calibrated version of the model we show that the externality and the lack of other policy instruments do not justify sizeable departures from price stability.

Pages: 47 pages
Date: 2013-08
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:udt:wpecon:2013-3

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