Optimal Monetary and Fiscal Policies in Disaggregated Economies

The jointly optimal monetary and fiscal policy mix in a multi-sector New Keynesian model with sectoral government spending and productivity shocks entails a separation of roles: Sectoral government spending optimally adjusts to sectoral output gaps and inflation rates---a policy supported by evidenc...

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Published in:NBER Working Paper Series 2024-09
Main Authors: Cox, Lydia, Feng, Jiacheng, Müller, Gernot, Pastén, Ernesto, Schoenle, Raphael, Weber, Michael
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Feng, Jiacheng
Müller, Gernot
Pastén, Ernesto
Schoenle, Raphael
Weber, Michael
description The jointly optimal monetary and fiscal policy mix in a multi-sector New Keynesian model with sectoral government spending and productivity shocks entails a separation of roles: Sectoral government spending optimally adjusts to sectoral output gaps and inflation rates---a policy supported by evidence from sectoral federal procurement data. Monetary policy optimally focuses on aggregate stabilization, but deviates from a zero-inflation target; in a model calibration to the U.S., however, it effectively approximates a zero-inflation target. Because monetary policy is a blunt instrument and government spending trades off stabilization against the optimal-level public good provision, the first best is not achieved.
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