Optimal Fiscal and Monetary Policy Under Sticky Prices

Stephanie Schmitt-Grohé () and Martín Uribe

No 9220, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper studies optimal .scal and monetary policy under sticky product prices. The theoretical framework is a stochastic production economy without capital. The government finances an exogenous stream of purchases by levying distortionary income taxes, printing money, and issuing one-period nominally risk-free bonds. The main findings of the paper are: First, for a miniscule degree of price stickiness (i.e., many times below available empirical estimates)the optimal volatility of in.ation is near zero. This result stands in stark contrast with the high volatility of inflation implied by the Ramsey allocation when prices are flexible. The finding is in line with a recent body of work on optimal monetary policy under nominal rigidities that ignores the role of optimal fiscal policy. Second, even small deviations from full price flexibility induce near random walk behavior in government debt and tax rates, as in economies with real non-state-contingent debt only. Finally, sluggish price adjustment raises the average nominal interest rate above the one called for by the Friedman rule.

JEL-codes: E52 E61 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mon and nep-rmg
Date: 2002-09
Note: EFG
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Related works:
Journal Article: Optimal fiscal and monetary policy under sticky prices (2004)
Journal Article: Optimal fiscal and monetary policy under sticky prices (2001)
Working Paper: Optimal Fiscal and Monetary Policy Under Sticky Prices (2001)
Working Paper: Optimal Fiscal and Monetary Policy Under Sticky Prices (2001)
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