Optimal fiscal and monetary policy under imperfect competition

This paper studies optimal fiscal and monetary policy under imperfect competition in a stochastic, flexible-price, production economy without capital. It shows analytically that in this economy the nominal interest rate acts as an indirect tax on monopoly profits. Unless the social planner has acces...

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Bibliographic Details
Published in:Journal of macroeconomics 2004-06, Vol.26 (2), p.183-209
Main Authors: Schmitt-Grohé, Stephanie, Uribe, Martı́n
Format: Article
Language:English
Subjects:
Capital
Competition
Economics
Fiscal policy
Friedman rule
Imperfect competition
Interest rates
Macroeconomics
Monetary policy
Optimal fiscal and monetary policy
Optimization
Profit taxes
Stochastic models
Studies
Taxation
Taxes
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Summary:This paper studies optimal fiscal and monetary policy under imperfect competition in a stochastic, flexible-price, production economy without capital. It shows analytically that in this economy the nominal interest rate acts as an indirect tax on monopoly profits. Unless the social planner has access to a direct 100% tax on profits, he will always find it optimal to deviate from the Friedman rule by setting a positive and time-varying nominal interest rate. The dynamic properties of the Ramsey allocation are characterized numerically. As in the perfectly competitive case, the labor income tax is remarkably smooth, whereas inflation is highly volatile and serially uncorrelated. An exact numerical solution method to the Ramsey conditions is proposed.
ISSN:0164-0704
1873-152X
DOI:10.1016/j.jmacro.2003.11.002