Optimal fiscal and monetary policy under different fiscal instruments

Abstract

Purpose

The paper includes characterizing Ramsey policy in a cash-in-advance monetary model, under flexible and sticky prices, and with different fiscal instruments.

Design/methodology/approach

The paper analytically and numerically characterizes the dynamic properties of Ramsey allocations. The author computes dynamics by solving second-order approximations to the Ramsey planner’s policy functions around a non-stochastic Ramsey steady state.

Findings

The Friedman rule is not mainly optimal in a cash-in-advance model with distorting taxes. The Ramsey-optimal policy with both taxes on income and consumption calls for a high inflation rate that is extremely volatile, despite the fact that changing prices is costly.

Practical implications

The optimality of zero nominal interest rate under flexible prices in monetary models is not mainly the case and quite depends on the preferences. The optimality of a zero inflation rate under sticky prices also very much depends on the assumed set of fiscal instruments.

Originality/value

The non-optimality of the Friedman rule under flexible prices is quite new. Moreover, studying the optimal fiscal and monetary policy in a New Keynesian model with a rich set of fiscal instruments is also quite original.

Citation

Kiarsi, M. (2021), "Optimal fiscal and monetary policy under different fiscal instruments", Journal of Economic Studies, Vol. 48 No. 1, pp. 167-190. https://doi.org/10.1108/JES-11-2019-0508