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Targeting inflation and the fiscal balance : what is the optimal policy mix?
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 ...
Going global : the changing pattern of U.S. investment abroad
Investors typically allocate only a small share of their portfolios to foreign assets. This pattern of investment behavior, known as ?home bias,? is puzzling because it causes investors to miss opportunities to diversify risks. During downturns in the U.S. economy, many domestic assets perform poorly, precisely when asset returns are most valuable. By purchasing foreign assets that are only partly affected by the U.S. business cycle, however, investors are able to hedge against adverse fluctuations in domestic income. ; Recent evidence suggests that home bias might actually be declining. Over ...
The performance of monetary and fiscal rules in an open economy with imperfect capital mobility
This paper studies monetary and fiscal policy rules, and investigates the characteristics of optimal policies. The central focus of the paper is on the comparison of two types of fiscal rules: a balanced budget and a target for the primary surplus. Balanced budget rules (or, more generally, numeric ceilings to the overall budget deficit) are criticized because they may dictate higher taxes in periods of weak economic activity. The primary surplus rule, in contrast, has a less pro-cyclical nature, given that it does not require higher fiscal austerity in periods when the cost of servicing ...
Do we really know how inflation targeters set interest rates?
In inflation targeting (IT) regimes, the Monetary Authority announces an explicit objective, the target for inflation. However, other objectives that possibly conflict with the inflation goal are present, such as keeping output close to its potential level and the stability of financial markets. This multiplicity of objectives has spurred a debate on whether inflation targeting really provides a transparent framework for monetary policy. This question is addressed in this paper, focusing on the experience of six countries that adopted IT. The empirical investigation is based on a variety of ...