Optimal fiscal and monetary policy when money is essential

We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income...

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Published inJournal of economic theory Vol. 145; no. 5; pp. 1618 - 1647
Main Authors Aruoba, S. Borağan, Chugh, Sanjay K.
Format Journal Article
LanguageEnglish
Published New York Elsevier Inc 01.09.2010
Elsevier
Elsevier Science Publishing Company, Inc
SeriesJournal of Economic Theory
Subjects
Demand for money
Distortion
Documents
Economic models
Economics
Fiscal policy
Friction
Friedman Rule
Friedman Rule Intertemporal distortions Micro-founded models of money
Income
Inflation rate
Intertemporal distortions
Joints
Micro-founded models of money
Monetary dynamics
Monetary economics
Monetary policy
Monetary theory
Optimization
Policies
Studies
Tax rates
Taxation
E62
E52
E63
Friedman Rule
E13
Micro-founded models of money
Intertemporal distortions
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Abstract We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income tax is not zero. Neither of these results is due to any incompleteness of the tax system, as can sometimes occur in standard Ramsey analysis. Rather, by developing a precise notion of margins of adjustment using standard concepts of MRS and MRT, we show that the tax system in our model is complete. The need to distort cash-intensive activity in some sense causes a nonzero capital tax in our model. This deep connection between monetary issues and fiscal policy is in contrast to existing models of jointly-optimal fiscal and monetary policy, in which the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Taken together, these findings reframe some conventional wisdom from baseline Ramsey models.
AbstractList We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income tax is not zero. Neither of these results is due to any incompleteness of the tax system, as can sometimes occur in standard Ramsey analysis. Rather, by developing a precise notion of margins of adjustment using standard concepts of MRS and MRT, we show that the tax system in our model is complete. The need to distort cash-intensive activity in some sense causes a nonzero capital tax in our model. This deep connection between monetary issues and fiscal policy is in contrast to existing models of jointly-optimal fiscal and monetary policy, in which the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Taken together, these findings reframe some conventional wisdom from baseline Ramsey models. [PUBLICATION ABSTRACT]
We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income tax is not zero. Neither of these results is due to any incompleteness of the tax system, as can sometimes occur in standard Ramsey analysis. Rather, by developing a precise notion of margins of adjustment using standard concepts of MRS and MRT, we show that the tax system in our model is complete. The need to distort cash-intensive activity in some sense causes a nonzero capital tax in our model. This deep connection between monetary issues and fiscal policy is in contrast to existing models of jointly-optimal fiscal and monetary policy, in which the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Taken together, these findings reframe some conventional wisdom from baseline Ramsey models.
We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income tax is not zero. Neither of these results is due to any incompleteness of the tax system, as can sometimes occur in standard Ramsey analysis. Rather, by developing a precise notion of margins of adjustment using standard concepts of MRS and MRT, we show that the tax system in our model is complete. The need to distort cash-intensive activity in some sense causes a nonzero capital tax in our model. This deep connection between monetary issues and fiscal policy is in contrast to existing models of jointly-optimal fiscal and monetary policy, in which the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Taken together, these findings reframe some conventional wisdom from baseline Ramsey models.
We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. The two main results are that the Friedman Rule is typically not optimal, and the long-run capital income tax is not zero. Neither of these results is due to any incompleteness of the tax system, as can sometimes occur in standard Ramsey analysis. Rather, by developing a precise notion of margins of adjustment using standard concepts of MRS and MRT, we show that the tax system in our model is complete. The need to distort cash-intensive activity in some sense causes a nonzero capital tax in our model. This deep connection between monetary issues and fiscal policy is in contrast to existing models of jointly-optimal fiscal and monetary policy, in which the monetary aspects of the economic environment have little to do with capital taxation prescriptions. Taken together, these findings reframe some conventional wisdom from baseline Ramsey models. All rights reserved, Elsevier
Author Chugh, Sanjay K.
Aruoba, S. Borağan
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Snippet We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it...
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SubjectTerms Demand for money
Distortion
Documents
Economic models
Economics
Fiscal policy
Friction
Friedman Rule
Friedman Rule Intertemporal distortions Micro-founded models of money
Income
Inflation rate
Intertemporal distortions
Joints
Micro-founded models of money
Monetary dynamics
Monetary economics
Monetary policy
Monetary theory
Optimization
Policies
Studies
Tax rates
Taxation
Title Optimal fiscal and monetary policy when money is essential
URI https://dx.doi.org/10.1016/j.jet.2010.03.009
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Volume 145
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