Optimal Fiscal and Monetary Policy

119 Pages Posted: 19 Jul 2000 Last revised: 31 Oct 2022

See all articles by Varadarajan V. Chari

Varadarajan V. Chari

University of Minnesota - Twin Cities - Department of Economics; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: January 1999

Abstract

We provide an introduction to optimal fiscal and monetary policy using the primal approach to optimal taxation. We use this approach to address how fiscal and monetary policy should be set over the long run and over the business cycle. We find four substantive lessons for policymaking: Capital income taxes should be high initially and then roughly zero; tax rates on labor and consumption should be roughly constant; state-contingent taxes on assets should be used to provide insurance against adverse shocks; and monetary policy should be conducted so as to keep nominal interest rates close to zero. We begin optimal taxation in a static context. We then develop a general framework to analyze optimal fiscal policy. Finally, we analyze optimal monetary policy in three commonly used models of money: a cash-credit economy, a money-in-the-utility-function economy

Suggested Citation

Chari, Varadarajan V. and Kehoe, Patrick J., Optimal Fiscal and Monetary Policy (January 1999). NBER Working Paper No. w6891, Available at SSRN: https://ssrn.com/abstract=227630

Varadarajan V. Chari (Contact Author)

University of Minnesota - Twin Cities - Department of Economics ( email )

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Federal Reserve Bank of Minneapolis ( email )

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National Bureau of Economic Research (NBER)

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Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department ( email )

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Minneapolis, MN 55480
United States
612-204-5525 (Phone)
612-204-5515 (Fax)

University of Minnesota - Twin Cities - Department of Economics ( email )

271 19th Avenue South
Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States