Optimal fiscal and monetary policy under sticky prices

Stephanie Schmitt-Grohe and Martín Uribe ()

Proceedings, 2001, issue Jun

Abstract: This paper studies optimal fiscal 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 inflation 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. Third, sluggish price adjustment raises the average nominal interest rate above the one called for by the Friedman rule. Finally, an interest-rate feedback rule whereby the nominal interest rate depends on inflation and output fits well the data emanating from the Ramsey economy. However, the fitted rule is not of the Taylor type, for the implied inflation coefficient is less than one and close to zero and the output coefficient is negative.

Keywords: Monetary policy; Prices; Fiscal policy (search for similar items in EconPapers)
Date: 2001
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

Downloads: (external link)
https://www.frbsf.org/wp-content/uploads/conf6b.pdf Full Text (text/html)

Related works:
Journal Article: Optimal fiscal and monetary policy under sticky prices (2004)
Working Paper: Optimal Fiscal and Monetary Policy Under Sticky Prices (2002)
Working Paper: Optimal Fiscal and Monetary Policy Under Sticky Prices (2001)
Working Paper: Optimal Fiscal and Monetary Policy Under Sticky Prices (2001)
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:fedfpr:y:2001:i:jun:x:1

Ordering information: This journal article can be ordered from

Access Statistics for this article

More articles in Proceedings from Federal Reserve Bank of San Francisco Contact information at EDIRC.
Bibliographic data for series maintained by Federal Reserve Bank of San Francisco Research Library ().