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Targeting Inflation and the Fiscal Balance:
What is the Optimal Policy Mix? By Marcela Meirelles Aurelio |
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Abstract This paper identifies optimal policy rules in the presence of explicit
targets for both the inflation rate and public debt. This issue is
investigated in the context of a dynamic stochastic general equilibrium
model that describes a small open economy with capital accumulation,
distortionary taxation and nominal price rigidities. The model is solved
using a second-order approximation to the equilibrium conditions. Optimal
policy features a strong anti-inflation stance and strict fiscal discipline.
Targeting a domestic inflation index - as opposed to CPI - improves welfare
because it reduces the inefficiencies that stem from both price stickiness
and income taxes. Keywords: Fiscal and inflation targets, optimal policy rules, sticky
prices, distortionary taxation |
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