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Optimal Fiscal and Monetary Policy: Equivalence Results

Isabel Correia (), Pedro Teles () and Juan Pablo Nicolini ()

Working Papers from Banco de Portugal, Economics and Research Department

Abstract: In this paper, we analyze the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be financed with distortionary taxes. We show that the sets of (frontier) implementable allocations are the same independently of the degree of price stickiness. Furthermore, the sets of policies that decentralize each allocation are also the same except in the extreme cases of flexible and sticky prices, where the sets are larger but still include that common set of policies. In this sense we establish an irrelevance or equivalence of environments. We also describe the minimal set of instruments, in the different environments, and thus discuss equivalence and neutrality of fiscal and monetary instruments. In particular we show that state contingent debt is not necessary, provided there are both consumption and labor income taxes.

JEL-codes: E31 E40 E52 E58 E62 E63 (search for similar items in EconPapers)
Date: 2003
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Related works:
Journal Article: Optimal Fiscal and Monetary Policy: Equivalence Results (2008) Downloads
Working Paper: Optimal fiscal and monetary policy: equivalence results (2008) Downloads
Working Paper: Optimal Fiscal and Monetary Policy: Equivalence Results (2003) Downloads
Working Paper: Optimal fiscal and monetary policy: equivalence results (2002) Downloads
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