Pedro Teles

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.

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.

Nominal debt as a burden on monetary policy

We study a dynamic equilibrium model where the same optimal monetary policy is implemented with and without full commitment if government debt is indexed. In contrast, with nominal debt, the full commitment policy is time inconsistent, since the government is tempted to inflate away its nominal liabilities. We characterize the optimal sequential policy. It has the feature that government debt is progressively depleted, and so, eventually, the time inconsistency problem vanishes. We compare this equilibrium to a myopic solution and to the Ramsey solution.

The Optimal Mix of Taxes on Money, Consumption and Income

We determine the optimal combination of taxes on money, consumption and income in transactions technology models where exogenous government expenditures must be financed with distortionary taxes. We show that the optimal policy does not tax money, regardless of whether the government can use as alternative fiscal instruments an income tax, a consumption tax, or the two taxes jointly. These results are at odds with recent literature. We argue that the reason for this divergence is an inappropriate specification of the transactions technology adopted in the literature.

Is Quantity Theory Still Alive

This paper investigates whether the quantity theory of money is still alive. We demonstrate three insights. First, for countries with low inflation, the raw relationship between average inflation and the growth rate of money is tenuous at best. Second, the fit markedly improves, when correcting for variation in output growth and the opportunity cost of money, using elasticities implied by theories of Baumol-Tobin and Miller-Orr. Finally, the sample after 1990 shows considerably less inflation variability, worsening the fit of a one-for-one relationship between money growth and inflation, and generates a fairly low elasticity of money demand.

Inside-Outside Money Competition

We study how competition from privately supplied currency substitutes affects monetary equilibria. Whenever currency is inefficiently provided,inside money competition plays a disciplinary role by providing an upper bound on equilibrium inflation rates. Furthermore,if ‘‘inside monies’’ can be produced at a sufficiently low cost,outside money is driven out of circulation. Whenever a ‘benevolent’ government can commit to its fiscal policy,sequential monetary policy is efficient and inside money competition plays no role. r 2003 Elsevier B.V. All rights reserved. JEL classification: E40; E50; E58; E60

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.

Monetary policy with single instrument feedback rules

We consider a standard cash in advance monetary model with flexible prices or prices set in advance and show that there are interest rate or money supply rules such that equilibria are unique. The existence of these single instrument rules depends on whether the economy has an infinite horizon or an arbitrarily large but finite horizon.