Working Paper: CEPR ID: DP3713
Authors: Stefania Albanesi
Abstract: This Paper studies the structure and time consistency of optimal monetary policy from a public finance perspective in an economy where agents differ in transaction patterns and asset holdings. I find that heterogeneity breaks the link between lack of government commitment and high inflation, which characterizes representative agent models of optimal fiscal and monetary policy. Even under commitment, it may be optimal to depart from Friedman?s rule for setting nominal interest rates. Moreover, optimal monetary and fiscal policies are time consistent. Time consistency does not require outstanding nominal claims on the government to be zero.
Keywords: heterogeneity; inflation; redistribution; time consistency
JEL Codes: E40; E50; E60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Heterogeneity in transaction patterns and asset holdings (G59) | High inflation is not exclusively associated with a lack of government commitment when agents are heterogeneous (E19) |
| Even under government commitment (H11) | Departure from Friedman’s rule is influenced by the distribution of nominal claims on the government and constraints on labor income taxation (H31) |
| Optimal monetary and fiscal policies can be made time consistent (E61) | Appropriately selecting the distribution of nominal claims on the government mitigates nominal time inconsistency (H00) |
| The optimality of the Friedman rule is not a necessary condition for time consistency of Ramsey policies (H21) | As long as the government can issue both real and nominal debt of varying maturities (H63) |
| With heterogeneous agents, the distributional effects of policies must be considered (D39) | To maintain time consistency (C41) |