Technical Appendix to "Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity"

This is the complete technical appendix to "Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity".

Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity

This paper characterizes optimal fiscal and monetary policy in a new keynesian model with sectorial heterogeneity in price stickiness. In particular, we (i) derive a purely quadratic welfare-based loss function from an approximation of the representative agent's utility function and (ii) provide the optimal target rule for fiscal and monetary policy. Differently from the homogeneous case, the loss function includes sectorial inflation variances instead of aggregate inflation, with weights proportional to the degree of price stickiness; and sectorial output gaps instead of aggregate output gap with equal weight in each sector. Optimal policy implies a very strong positive correlation among sectorial output gaps and some dispersion of sectorial inflation in response to shocks. Larger heterogeneity in price stickiness implies larger impact of shocks on aggregate inflation. Optimal taxes are more responsive in sectors with stickier prices.

Stabilizing Inflation under Heterogeneity: a welfare-based measure on what to target

What measure of inflation a Central Bank should respond to? This paper characterizes the optimal targeting index in a multisectorial economy with Calvo-pricing, defined as a composition of sectorial inflations that maximizes a selected welfare criterion. This is a purely quadratic approximation to the representative agent's utility in an environment of distorted steady state and sectorial heterogeneity of price stickiness. The Central Bank is modeled as following a historical Taylor Rule. For most parameter values, weights of sectorial inflations are increasing functions of the degrees of nominal rigidity and productivity volatility and decreasing functions of sectorial wage markup volatilities, resembling most of the conclusions from related literature. Bayesian estimation for the structural model using sectorial quantum and price indexes for Personal Consumption Expenditure (PCE) provides the parameter values that allow constructing the optimal index for the US economy. The result points out towards a price index with similar properties than the PCE, with more weight on services and less weight of inflation from durable goods. I find no evidence that a core index based on the exclusion of food and energy goods is welfare improving.Inflation Targeting; Heterogeneity of price stickiness; Optimal inflation measure

Stabilizing Inflation under Heterogeneity: a welfare-based measure on what to target

What measure of inflation a Central Bank should respond to? This paper characterizes the optimal targeting index in a multisectorial economy with Calvo-pricing, defined as a composition of sectorial inflations that maximizes a selected welfare criterion. This is a purely quadratic approximation to the representative agent's utility in an environment of distorted steady state and sectorial heterogeneity of price stickiness. The Central Bank is modeled as following a historical Taylor Rule. For most parameter values, weights of sectorial inflations are increasing functions of the degrees of nominal rigidity and productivity volatility and decreasing functions of sectorial wage markup volatilities, resembling most of the conclusions from related literature. Bayesian estimation for the structural model using sectorial quantum and price indexes for Personal Consumption Expenditure (PCE) provides the parameter values that allow constructing the optimal index for the US economy. The result points out towards a price index with similar properties than the PCE, with more weight on services and less weight of inflation from durable goods. I find no evidence that a core index based on the exclusion of food and energy goods is welfare improving

Stabilizing Inflation under Heterogeneity: a welfare-based measure on what to target

What measure of inflation a Central Bank should respond to? This paper characterizes the optimal targeting index in a multisectorial economy with Calvo-pricing, defined as a composition of sectorial inflations that maximizes a selected welfare criterion. This is a purely quadratic approximation to the representative agent's utility in an environment of distorted steady state and sectorial heterogeneity of price stickiness. The Central Bank is modeled as following a historical Taylor Rule. For most parameter values, weights of sectorial inflations are increasing functions of the degrees of nominal rigidity and productivity volatility and decreasing functions of sectorial wage markup volatilities, resembling most of the conclusions from related literature. Bayesian estimation for the structural model using sectorial quantum and price indexes for Personal Consumption Expenditure (PCE) provides the parameter values that allow constructing the optimal index for the US economy. The result points out towards a price index with similar properties than the PCE, with more weight on services and less weight of inflation from durable goods. I find no evidence that a core index based on the exclusion of food and energy goods is welfare improving

Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity

This paper characterizes optimal fiscal and monetary policy in a new keynesian model with sectorial heterogeneity in price stickiness. In particular, we (i) derive a purely quadratic welfare-based loss function from an approximation of the representative agent's utility function and (ii) provide the optimal target rule for fiscal and monetary policy. Differently from the homogeneous case, the loss function includes sectorial inflation variances instead of aggregate inflation, with weights proportional to the degree of price stickiness; and sectorial output gaps instead of aggregate output gap with equal weight in each sector. Optimal policy implies a very strong positive correlation among sectorial output gaps and some dispersion of sectorial inflation in response to shocks. Larger heterogeneity in price stickiness implies larger impact of shocks on aggregate inflation. Optimal taxes are more responsive in sectors with stickier prices

Real Business Cycle Dynamics under Rational Inattention

This paper incorporates Rational Inattention as defined by Sims (2003a) to a traditional RBC model with multiple sources of uncertainty. Our model distinguishes between transitory and permanent labor and relative investment productivity shocks. The introduction of information frictions works as an endogenous adjustment cost: given the model parameters, the degree of sluggishness of endogenous variables in response to shocks is optimally determined. In practical terms, Rational Inattention increases the volatility and the contemporaneous correlations with output of consumption and decreases those of investment and hours. Moreover, it generates a trade-off between short-run and long-run shock variances. We believe these effects might have important welfare implications and can provide an analytical understanding on the links between business cycle fluctuations and the long-run performance of an economy

Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity

This paper characterizes optimal fiscal and monetary policy in a new keynesian model with sectorial heterogeneity in price stickiness. In particular, we (i) derive a purely quadratic welfare-based loss function from an approximation of the representative agent's utility function and (ii) provide the optimal target rule for fiscal and monetary policy. Differently from the homogeneous case, the loss function includes sectorial inflation variances instead of aggregate inflation, with weights proportional to the degree of price stickiness; and sectorial output gaps instead of aggregate output gap with equal weight in each sector. Optimal policy implies a very strong positive correlation among sectorial output gaps and some dispersion of sectorial inflation in response to shocks. Larger heterogeneity in price stickiness implies larger impact of shocks on aggregate inflation. Optimal taxes are more responsive in sectors with stickier prices

Real Business Cycle Dynamics under Rational Inattention

This paper incorporates Rational Inattention as defined by Sims (2003a) to a traditional RBC model with multiple sources of uncertainty. Our model distinguishes between transitory and permanent labor and relative investment productivity shocks. The introduction of information frictions works as an endogenous adjustment cost: given the model parameters, the degree of sluggishness of endogenous variables in response to shocks is optimally determined. In practical terms, Rational Inattention increases the volatility and the contemporaneous correlations with output of consumption and decreases those of investment and hours. Moreover, it generates a trade-off between short-run and long-run shock variances. We believe these effects might have important welfare implications and can provide an analytical understanding on the links between business cycle fluctuations and the long-run performance of an economy

Technical Appendix to "Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity"

This is the complete technical appendix to "Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity"