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Optimal policy with general signal extraction

Esther Hauk (), Andrea Lanteri () and Albert Marcet ()

Journal of Monetary Economics, 2021, vol. 118, issue C, 54-86

Abstract: Most available results on optimal decisions under partial information are derived under “separation”. But this principle does not always hold. We derive a non-standard first order condition of optimality from first principles when signal extraction and optimal policy must be jointly determined. This allows us to solve a model of optimal fiscal policy where separation does not apply. Tax smoothing prevails in normal times, but taxes respond strongly in recessions. This non-linearity arises because signal extraction interacts differently with optimal policy depending on the value of the observed signals. Existing results based on the “separation principle” follow as special cases.

Keywords: Optimal policy; Partial information; Calculus of variations; Fiscal policy (search for similar items in EconPapers)
JEL-codes: D80 E62 H21 (search for similar items in EconPapers)
Date: 2021
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Working Paper: Optimal Policy with General Signal Extraction (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:118:y:2021:i:c:p:54-86

DOI: 10.1016/j.jmoneco.2021.01.002

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