Optimal Policy with General Signal Extraction

64 Pages Posted: 26 Sep 2016  

Esther Hauk

Instituto de Análisis Económic (IAE) Barcelona

Andrea Lanteri

Duke University - Department of Economics

Albert Marcet

Universitat Autònoma de Barcelona - Institut d'Anàlisi Economica CSIC

Date Written: September 26, 2016

Abstract

This paper studies optimal policy with partial information in a general setup where observed signals are endogenous to policy. In this case, signal extraction about the state of the economy cannot be separated from the determination of the optimal policy. We derive a non-standard first order condition of optimality from first principles and we use it to find numerical solutions. We show how previous results based on linear methods, where separation or certainty equivalence obtains, arise as special cases. We use as an example a model of fiscal policy and show that optimal taxes are often a very non-linear function of observed hours, calling for tax smoothing in normal times, but for a strong fiscal reaction to output when a recession is quite certain and the economy is near the top of the Laffer curve or near a debt limit.

Suggested Citation

Hauk, Esther and Lanteri, Andrea and Marcet, Albert, Optimal Policy with General Signal Extraction (September 26, 2016). Economic Research Initiatives at Duke (ERID) Working Paper No. 230. Available at SSRN: https://ssrn.com/abstract=2843710 or http://dx.doi.org/10.2139/ssrn.2843710

Esther Hauk

Instituto de Análisis Económic (IAE) Barcelona ( email )

Barcelona, Bellaterra 08193
Spain

Andrea Lanteri (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

Albert Marcet

Universitat Autònoma de Barcelona - Institut d'Anàlisi Economica CSIC ( email )

Edifici B
Bellaterra, 08193
Spain

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