Optimal Fiscal and Monetary Policy Under Sticky Prices

This paper studies optimal .scal 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 in.ation 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, as in economies with real non-state-contingent debt only. Finally, sluggish price adjustment raises the average nominal interest rate above the one called for by the Friedman rule.

The analysis steady to not structural uncertaintya monetary and fiscal policy at their cooperation interaction

The search for a fiscal and monetary policy that is robust to uncertainty and does not lead to negative consequences for any possible distortion specifications of the economic model, is particularly relevant to the development of dynamic models. It is of scientific and practical interest to study the effect of the degree of the dominance of monetary and fiscal authorities over each other on policy stability. In this article, a neo-Keynesian model is used as a case to study the effect of the degree of cooperation between the Сentral Bank and the government on policy stability. Analysis is performed of robustness to non-structural uncertainties of fiscal and monetary policies with cooperative interaction between the monetary and fiscal authorities for the regime with the obligations and discretionary policy regime. Recommendations are offered for the development of robustness of non-structural policy uncertainties. Economic-mathematical methods and computer simulation methods were used in the study of sustainability issues to the uncertainties of fiscal and monetary policy. It was found that the coordinated interaction of fiscal and monetary authorities to the regime with obligations and discretionary mode is effective only in the case of a greater negotiating power of the Сentral Bank. This is true for the model with the worst-case scenario, and for models resistant to policy uncertainty. For the regime with obligations, the growing degree dominance of the government leads to distortions in the main response of government spending on inflation shock. With an increasing degree of government dominance in cooperation with the Central Bank under a discretionary policy the role of the distortions introduced by the standard model is reduced. In the case of a policy with commitments and under a discretionary policy the distortions brought to the standard model at a shock of demand, are minimal. It is concluded that that the analysis of monetary and fiscal policy in the macroeconomic dynamic models should take into account the obtained results outlined in this paper when developing a policy that is resistant to non-structural uncertainties.Поиск устойчивой к неопределенности фискальной и монетарной политики, не приводящей к отрицательным последствиям при любых возможных искажениях спецификации экономической модели, является особенно актуальным при разработке динамических моделей. При этом представляет научный и практический интерес влияние степени доминирования монетарных и фискальных властей друг над другом на устойчивость политики. В данной публикации на примере неокейнсианской модели исследовано влияние степени сотрудничества Центробанка и правительства на устойчивость политики. При исследовании проблемы устойчивости к неопределенностям фискальной и монетарной политики использовались экономико-математические методы и методы компьютерного моделирования. Установлено, что скоординированное взаимодействие фискальной и монетарной власти для режима с обязательствами и для дискреционного режима эффективно лишь при большей переговорной силе Центрального банка. Это справедливо как для модели с наихудшим сценарием, так и для модели с устойчивой к неопределенностям политики. Для режима с обязательствами увеличение степени доминирования правительства приводит в основном к искажениям отклика госрасходов на шок инфляционных издержек. С увеличением степени доминирования правительства в сотрудничестве с Центральным банком при дискреционной политике роль искажений, вносимых в стандартную модель, уменьшается. При режиме с обязательствами и при дискреционной политике искажения, вносимые в стандартную модель при шоках спроса, минимальны. Полученные результаты могут использоваться при анализе крупномасштабных динамических стохастических моделей. Сделан вывод, о том, что при анализе монетарной и фискальной политики в макроэкономических динамических моделях, следует принимать во внимание полученные в данной статье результаты по разработке устойчивой к неструктурным неопределенностям политики

Second Order Accurate Approximation to the Rotemberg Model Around a Distorted Steady State

Less is known about social welfare objectives when it is costly to change prices, as in Rotemberg (1982), compared with Calvo-type models. We derive a quadratic approximate welfare function around a distorted steady state for the costly price adjustment model. We highlight the similarities and differences to the Calvo setup. Both models imply inflation and output stabilization goals. It is explained why the degree of distortion in the economy influences inflation aversion in the Rotemberg framework in a way that differs from the Calvo setup.Price Stickiness, Rotemberg Model, Costly Price Adjustment.

Moderate inflation and the deflation-depression link

In a recent paper, Atkeson and Kehoe (2004) demonstrated the lack of a robust empirical relationship between inflation and growth for a cross-section of countries with 19th and 20th century data, concluding that the historical evidence only provides weak support for the contention that deflation episodes are harmful to economic growth. In this paper, we revisit this relationship by allowing for inflation and growth to have a nonlinear specification dependent on inflation levels. In particular, we allow for the possibility that high inflation is negatively correlated with growth, while a positive relationship exists over the range of negative-to-moderate inflation. Our results confirm a positive relationship between inflation and growth at moderate inflation levels, and support the contention that the relationship between inflation and growth is non-linear over the entire sample range.Inflation (Finance)

The Influence of Monetary and Fiscal Policies on Social Welfare

The paper analyses the way in which monetary and fiscal policy influences the performances of economic growth and social welfare. The analysis is made on the basis of a dynamic model with discrete variables. The model is with a representative private agent and a government sector consisting of a consolidated fiscal authority and central bank. Households, in each period, decide about consumption, investment in physical capital, and financial investment in government bonds. The model is built in such a way that satisfaction of the budget constraint of the representative household implies satisfaction of the budget constraint of the government. The model has two state variables: the first is private wealth (consisting of money, bonds and physical capital), and the second is physical capital. The decision variables are: private nominal consumption, social nominal consumption and the amount of bonds bought by the private agent. The optimality conditions are obtained by using the Maximum Principle for discrete dynamic systems. A qualitative analysis of the optimal trajectories is performed, on the basis of the information provided by the Maximum Principle, concerning the dynamics of the dual variables. Finally, we analyze the influence of several monetary and fiscal decisions on the optimal trajectories of the model.Economic Growth, Monetary Policy, Fiscal Policy, Fiscal Solvency, Maximum Principle

Welfare implications of Calvo vs. Rotemberg pricing assumptions

This paper compares the welfare implications of two widely used pricing assumptions in the New-Keynesian literature: Calvo-pricing vs. Rotemberg-pricing. We show that despite the strong similarities between the two assumptions to a first order of approximation, in general they might entail different welfare costs at higher order of approximation. In the special case of non-distorted steady state, the two pricing assumptions imply identical welfare losses to a second order of approximation. JEL Classification: E3, E5Calvo price adjustment, inflation, Rotemberg price adjustment, second-order approximation, Welfare

On the International Dimension of Fiscal Policy

This paper analyses the international dimension of fiscal policy using a small open economy framework in which the government finances its spending by levying distortionary taxation and issuing non-state-contingent debt. The main finding of the paper is that, once the open economy aspect of the policy problem is considered, it is not optimal to smooth taxes following idiosyncratic shocks. Even when prices are flexible and inflation can costlessly act as a shock absorber to restore fiscal equilibrium, the presence of a terms of trade externality lead to movements in the tax rate. Also in contrast with the closed economy, the introduction of sticky prices can reduce the optimal volatility of taxes.optimal policy, fiscal policy, small open economy