Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version

Stephanie Schmitt-Grohe and Martín Uribe ()

No 11417, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In this paper, we study Ramsey-optimal fiscal and monetary policy in a medium-scale model of the U.S.\ business cycle. The model features a rich array of real and nominal rigidities that have been identified in the recent empirical literature as salient in explaining observed aggregate fluctuations. The main result of the paper is that price stability appears to be a central goal of optimal monetary policy. The optimal rate of inflation under an income tax regime is half a percent per year with a volatility of 1.1 percent. This result is surprising given that the model features a number of frictions that in isolation would call for a volatile rate of inflation---particularly nonstate-contingent nominal public debt, no lump-sum taxes, and sticky wages. Under an income-tax regime, the optimal income tax rate is quite stable, with a mean of 30 percent and a standard deviation of 1.1 percent. Simple monetary and fiscal rules are shown to implement a competitive equilibrium that mimics well the one induced by the Ramsey policy. When the fiscal authority is allowed to tax capital and labor income at different rates, optimal fiscal policy is characterized by a large and volatile subsidy on capital.

JEL-codes: E52 E61 E63 (search for similar items in EconPapers)
Date: 2005-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Note: EFG ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (170)

Published as Gertler, Mark and Kenneth Rogoff (eds.) NBER Macroeconomics Annual. MIT Press: Cambridge MA, 2006, 383-425.
Published as Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model , Stephanie Schmitt-Grohé, Martín Uribe. in NBER Macroeconomics Annual 2005, Volume 20 , Gertler and Rogoff. 2006

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