Isabel Horta Correia

Business Cycles in a Small Open Economy

This paper discusses a dynamic model that is consistent with the main empirical regularities of economic fluctuations in open economies. While other models in this class have relied on non-separable preferences or finite horizons to generate a realistic consumption volatility, we show that there is a simple class of time separable preferences that is consistent with the cyclical volatilities of the components of the national income accounts identity as well as with the countercyclical character of the balance of trade.

Optimal Fiscal and Monetary Policy: Equivalence Results ∗

In this article, we analyze the implications of price-setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider standard monetary economies that differ in the price-setting restrictions imposed on the firms. We show that, independently of the degree or type of price stickiness, it is possible to implement the same efficient set of allocations and that each allocation in that set is implemented with policies that are also independent of the price stickiness. In this sense, environments with different price-setting restrictions are equivalent.

Should capital income be taxed in the steady state

This paper provides a new economic interpretation of the well-known dynamic optimal taxation principle that capital income should not be taxed in the steady state. We show that the result is related to the minimization of distortions at the intratemporal margin. When every factor of production can be taxed at the optimal rate, capital income should not be taxed in the steady state. But when there are restrictions on the taxation of production factors, the tax rate on capital income in the steady state is different from zero.

Is the Friedman rule optimal when money is an intermediate good

In contrast to the recent literature on the optimal inflation tax, we show that, in models where money reduces transactions costs, it is optimal to set the inflation tax to zero when seigniorage is replaced by revenue from distortionary taxes. The main reasons for this result are that the variable costs of supplying real balances are negligible and the inflation tax is a unit tax. We also show that the intermediate good optimal taxation rules, in the public finance literature, cannot be directly applied both when money is costless and when it requires resources to be produced.

Gaps and Triangles

We derive principles of optimal short run monetary policy in a real business cycles model, with money and with monopolistic firms that set prices one period in advance. The only distortionary policy intruments are the nominal interest rates and the money supplies. In this environment it is feasible to undo both the cash in advance and the price setting restrictions. We show that the optimal allocation is achieved under the Friedman rule. We also show that, in general, it is not optimal to undo the restriction that prices are set one period in advance. Sticky prices provide the planner with tools to improve upon a distorted flexible prices allocation.

Business Cycles in Portugal: Theory and Evidence

The main objective of this article is to describe the most important features of business cycles in Portugal during the period 1958-1989. We compare these features with the empirical regularities of economic fluctuations in other OECD countries and with the predictions of two benchmark dynamic general equilibrium models.

Dynamic optimal taxation in small open economies

Abstract This paper examines the effects of perfect capital mobility on the determination of optimal capital taxation. It shows that capital movements do not change dramatically the optimal tax path studied for the closed economy. In addition, the paper provides a counterexample to the standard belief that the worldwide system is the optimal regime of taxation. Finally it shows that the rate of taxation of the rest of the world is not fundamental to determine the optimal decision of a small economy.

On the efficiency and equity trade-off

Abstract The concept of policy measures that create a potential Pareto improvement has dominated normative economics. The use of this concept in welfare economics relies on the availability of discriminatory lump-sum transfers in such a way that the implementation of the efficient policy measure leads to a Pareto movement in the economy. However, most studies of efficient policies preclude by assumption the existence of lump-sum taxation. This paper proposes, in economies amenable to Gorman aggregation, one simple methodology to rank alternative allocations in terms of their distributional implications, in a world with no lump-sum transfers. This methodology is simple because it is independent of the distribution of characteristics in the economy. Then, for a specific policy measure, it can be easily identified whether it implies an equity-efficiency trade-off. The method is illustrated by analyzing the effects on inequality of the elimination of capital taxation, the reduction of the inflation tax, and the liberalization of capital movements in a small open economy.

The Monetary Transmission Mechanism: Is It Relevant for Policy?

We study environments with sticky prices, wages or portfolios where it is feasible and optimal to use monetary policy to replicate the allocation under full flexibility. In these environments the optimal policy does not depend on the scope of the frictions. In this sense, the strength of the monetary transmission mechanism is irrelevant for the conduct of monetary policy. So, asymmetries in the strength of the transmission mechanisms do not impose a cost on a common policy.

Monetary policy with state contingent interest rates

What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state- contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance.