Optimal Fiscal and Monetary Policy Under Imperfect Competition
Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)
Duke University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
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 percent 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 labor income tax is remarkably smooth, whereas inflation is highly volatile and serially uncorrelated. An exact numerical solution method to the Ramsey conditions is proposed.
Number of Pages in PDF File: 28
Keywords: Optimal Fiscal and Monetary Policy, Friedman rule, Imperfect competition
JEL Classification: E52, E61, E63
Date posted: January 29, 2001
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