Chapter20 - Chapter 20 Optimal Fiscal and Monetary Policy...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
© Sanjay K. Chugh 247 Spring 2008 Chapter 20 Optimal Fiscal and Monetary Policy We now proceed to study jointly optimal monetary and fiscal policy. The motivation behind this topic stems directly from observations regarding the consolidated government budget constraint. Specifically, a broad lesson emerging from our study of fiscal- monetary interactions is that money creation and thus inflation potentially helps the fiscal authority to pay for its government spending. Alternatively, a broad interpretation we made when we studied optimal monetary policy earlier was that steady-state inflation (more precisely, any steady-state deviation from the Friedman Rule) acted as a tax on consumers. At that stage, we did not note that a deviation from the Friedman Rule, acting as a “tax,” potentially raised revenue for the government; now, with our notion of a consolidated budget constraint, we are in a position to understand this latter idea. Here, the question that we take up is: if both monetary and fiscal policy are conducted optimally, what is the optimal steady-state mix of labor taxes and inflation needed to finance some fixed amount of government spending? Our approach to answering this question will hew very closely to the methods of analysis we have already developed in our separate looks at optimal monetary policy (without regard for fiscal policy) and optimal fiscal policy (without regard for monetary policy). The model we use to answer this question mostly combines elements we have already seen. To overview the key elements of the model we will use to try to think about our main question, our model will: - Feature an infinite number of periods - Model money using the money-in-the-utility function (MIU) approach - Feature labor income taxes as the only direct fiscal instrument (i.e., no consumption taxes and no taxes on savings) - Feature a consolidated government budget constraint - Feature a simple linear-in-labor production technology - Focus on the steady state Because by now most of these model elements are familiar to us, we will not spend much time developing the details of the basic model; rather we will spend most of our time analyzing the optimal policy problem and its solution. Firms The way in which we model firms is as we have often done: the representative firm simply hires labor each period in perfectly-competitive labor markets and sells its output. The production technology we assume here is also as simple as possible, linear in labor:
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
© Sanjay K. Chugh 248 Spring 2008 () tt t y fn n . Firms’ profits in period t (in nominal terms) are thus simply Py Wn ± , where the notation is standard: t P is the nominal price of goods, t W is the nominal wage, and t n is the quantity of labor. When the firm is maximizing profits, we assume it takes as given both the nominal price P and the nominal wage W .
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This document was uploaded on 11/01/2011 for the course ECON 325 at Maryland.

Page1 / 14

Chapter20 - Chapter 20 Optimal Fiscal and Monetary Policy...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online