Working Paper: CEPR ID: DP2688
Authors: Stephanie Schmitt-Groh; Martin Uribe
Abstract: This Paper studies optimal fiscal and monetary policy under imperfect competition in a stochastic, flexible-price, production economy without capital. It shows analytically that in this economy the nominal interest rate acts as an indirect tax on monopoly profits. Unless the social planner has access to a direct 100% tax on profits, he will always find it optimal to deviate from the Friedman rule by setting a positive and time-varying nominal interest rate. The dynamic properties of the Ramsey allocation are characterized numerically. As in the perfectly competitive case, the labour income tax is remarkably smooth, whereas inflation is highly volatile and serially uncorrelated. An exact numerical solution method to the Ramsey conditions is proposed.
Keywords: imperfect competition; optimal fiscal and monetary policy; Ramsey equilibria
JEL Codes: E52; E61; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Nominal interest rates (E43) | Monopoly profits (D42) |
| Markup over marginal cost (D40) | Nominal interest rates (E43) |
| Markup over marginal cost (D40) | Labor income tax rates (J39) |
| Nominal interest rates (E43) | Volatility of nominal interest rates (E43) |
| Market power (L11) | Nominal interest rates (E43) |
| Market power (L11) | Labor income tax rates (J39) |