DP3730 Optimal Fiscal and Monetary Policy: Equivalence Results

Author(s): Isabel Correia, Juan Pablo Nicolini, Pedro Teles
Publication Date: February 2003
Keyword(s): optimal fiscal and monetary policy, sticky prices
JEL(s): E31, E40, E52, E58, E62, E63
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3730

In this Paper, we analyse the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be financed with distortionary taxes. We show that the sets of (frontier) implementable allocations are the same independent of the degree of price stickiness. Furthermore, the sets of policies that decentralize each allocation are also the same except in the extreme cases of flexible and sticky prices, where the sets are larger.