Optimal Monetary Policy and Fiscal Interactions in a Non-Ricardian Economy
65 Pages Posted: 8 Dec 2017
Date Written: December 5, 2017
This paper studies optimal discretionary monetary policy and its interaction with fiscal policy in a New Keynesian model with finitely-lived consumers and government debt. Optimal discretionary monetary policy involves debt stabilization to reduce consumption dispersion across cohorts of consumers. The welfare relevance of debt stabilization is proportional to the debt-to-output ratio and inversely related to the households probability of survival that affects the household’s propensity to consume out financial wealth. Debt stabilization bias implies that discretionary optimal policy is suboptimal compared with the inflation targeting rule that fully stabilizes the output gap and the inflation rate while leaving debt to freely fluctuate in response to demand shocks.
Keywords: optimal monetary policy, fiscal and monetary policy interaction
JEL Classification: E53, E63
Suggested Citation: Suggested Citation