Optimal Simple and Implementable Monetary and Fiscal Rules

Martín Uribe () and Schmitt-Grohé, Stephanie
Authors registered in the RePEc Author Service: Stephanie Schmitt-Grohe

No 4334, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The goal of this Paper is to compute optimal monetary and fiscal policy rules in a real business cycle model augmented with sticky prices, a demand for money, taxation, and stochastic government consumption. We consider simple policy rules whereby the nominal interest rate is set as a function of output and inflation, and taxes are set as a function of total government liabilities. We require policy to be implementable in the sense that it guarantees uniqueness of equilibrium. We do away with a number of empirically unrealistic assumptions typically maintained in the related literature that are used to justify the computation of welfare using linear methods. Instead, we implement a second-order accurate solution to the model. Our main findings are: First, the size of the inflation coefficient in the interest-rate rule plays a minor role for welfare. It matters only insofar as it affects the determinacy of equilibrium. Second, optimal monetary policy features a muted response to output. More importantly, interest rate rules that feature a positive response of the nominal interest rate to output can lead to significant welfare losses. Third, the optimal fiscal policy is passive. The welfare losses associated with the adoption of an active fiscal stance are, however, negligible.

Keywords: Optimal fiscal and monetary policy; Nominal rigidities; Optimal inflation volatility; Second-order approximation techniques (search for similar items in EconPapers)
JEL-codes: E52 E61 E63 (search for similar items in EconPapers)
Date: 2004-03
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
References: Add references at CitEc
Citations: View citations in EconPapers (111)

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Related works:
Journal Article: Optimal simple and implementable monetary and fiscal rules (2007)
Working Paper: Optimal simple and implementable monetary and fiscal rules (2007)
Working Paper: Optimal Simple and Implementable Monetary and Fiscal Rules (2004)
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