DP15199 Stabilization vs. Redistribution: the Optimal Monetary-Fiscal Mix

Author(s): Florin Ovidiu Bilbiie, Tommaso Monacelli, Roberto Perotti
Publication Date: August 2020
Date Revised: June 2021
Keyword(s): aggregate demand, Fiscal Transfers, Inequality, Optimal Monetary-Fiscal Policy, redistribution, TANK
JEL(s): D91, E21, E62
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15199

Stabilization and redistribution are intertwined in a model with heterogeneity, imperfect insurance, and nominal rigidity---making fiscal and monetary policy inextricably linked for aggregate-demand management. Movements in inequality induced by fiscal transfers make the flexible-price equilibrium suboptimal, thus triggering a stabilization vs redistribution tradeoff. Likewise, changes in government spending that are associated with changes in the distribution of taxes (progressive vs. regressive) induce a tradeoff for monetary policy: the central bank cannot stabilize real activity at its efficient level (including insurance) and simultaneously avoid inflation. Fiscal policy can be used in conjunction to monetary policy to strike the optimal balance between stabilization and insurance (redistribution) motives.