NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Optimal Monetary and Fiscal Policy: A Linear Quadratic Approach

Pierpaolo Benigno, Michael Woodford

NBER Working Paper No. 9905
Issued in August 2003
NBER Program(s):   EFG   ME

We propose an integrated treatment of the problems of optimal monetary and fiscal policy, for an economy in which prices are sticky and the only available sources of government revenue are distorting taxes. Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, we derive targeting rules through which the monetary and fiscal authorities may implement the optimal equilibrium.

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Document Object Identifier (DOI): 10.3386/w9905

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