Working Paper: CEPR ID: DP4782
Authors: Robert Kollmann
Abstract: This Paper computes welfare-maximizing monetary and tax policy feedback rules, in a calibrated dynamic general equilibrium model with sticky prices. The government makes exogenous final good purchases, levies a proportional income tax, and issues nominal one-period bonds. A quadratic approximation method is used to solve the model, and to compute household welfare. Optimized policy has a strong anti-inflation stance and implies persistent fluctuations of the tax rate and of public debt. Very simple optimized policy rules, under which the interest rate just responds to inflation and the tax rate just responds to public debt, yield a welfare level very close to that generated by richer rules.
Keywords: Fiscal Policy; Monetary Policy; Welfare
JEL Codes: E50; E60; H60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimized policy rules that respond to inflation and public debt (E62) | welfare levels close to those produced by more complex rules (I30) |
| optimized policy (L21) | almost full inflation stabilization (E31) |
| almost full inflation stabilization (E31) | eliminates inefficient price dispersion across firms (L11) |
| persistent fluctuations in the tax rate and public debt (H69) | consequence of optimized policy (D78) |
| flexible price structure (D49) | significant inflation volatility and minimal movements in the tax rate (H29) |
| productivity shocks (O49) | drive macroeconomic fluctuations (E32) |
| government purchase shocks (H57) | less influential in driving macroeconomic fluctuations than productivity shocks (E39) |