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Author:Chari, V. V. 

Optimal fiscal and monetary policy

We provide an introduction to optimal fiscal and monetary policy using the primal approach to optimal taxation. We use this approach to address how fiscal and monetary policy should be set over the long run and over the business cycle. We find four substantive lessons for policymaking: Capital income taxes should be high initially and then roughly zero; tax rates on labor and consumption should be roughly constant; state-contingent taxes on assets should be used to provide insurance against adverse shocks; and monetary policy should be conducted so as to keep nominal interest rates close to ...
Staff Report , Paper 251

A reconsideration of the problem of social cost: free riders and monopolists

We examine the validity of one version of the Coase Theorem: In any economy in which property rights are fully allocated, competition will lead to efficient allocations. This version of the theorem implies that the public goods problem can be solved by allocating property rights fully and letting markets do their work. We show that this mechanism is not likely to work well in economies with either pure public goods or global externalities. The reason is that the privatized economy turns out to be highly susceptible to strategic behavior in that the free-rider problem in public goods economies ...
Staff Report , Paper 142

Sustainable plans and mutual default

This paper presents a simple general equilibrium model of optimal taxation in which both private agents and the government can default on their debt. As a benchmark we consider Ramsey equilibria in which the government can precommit to its policies at the beginning of time, but in which private agents can default. We then consider sustainable equilibria in which both government and private agent decision rules are required to be sequentially rational. We completely characterize the set of sustainable equilibria. In particular, we show that when there is sufficiently little discounting and ...
Staff Report , Paper 124

Optimal Capital Taxation Revisited

We revisit the question of how capital should be taxed. We allow for a rich set of tax instruments that consists of taxes widely used in practice, including consumption, dividend, capital, and labor income taxes. We restrict policies to respect promises that the government has made in the previous period regarding the current value of wealth. We show that capital should not be taxed if households have preferences that are standard in the macroeconomics literature. We show that Ramsey outcomes that must respect such promises are time consistent. We show that the presumption in the literature ...
Staff Report , Paper 571

Working Paper
On the need for fiscal constraints in a monetary union

Working Papers , Paper 589

Sudden stops and output drops

In recent financial crises and in recent theoretical studies of them, abrupt declines in capital inflows, or sudden stops, have been linked with large drops in output. Do sudden stops cause output drops? No, according to a standard equilibrium model in which sudden stops are generated by an abrupt tightening of a country?s collateral constraint on foreign borrowing. In this model, in fact, sudden stops lead to output increases, not decreases. An examination of the quantitative effects of a well-known sudden stop, in Mexico in the mid-1990s, confirms that a drop in output accompanying a sudden ...
Staff Report , Paper 353

Conference Paper
Optimal fiscal and monetary policy: some recent results


The poverty of nations: a quantitative exploration

We ask what fraction of the variation in incomes across countries can be accounted for by investment distortions. In our neoclassical growth model the relative price of investment to consumption is a good measure of the distortions. Using data on relative prices we estimate a stochastic process for distortions and compare the resulting variance of incomes in the model to that in the data. We find that the variation of incomes in the model is roughly 4/5 of the variability of incomes in the data. Our model does well in accounting for 6 key regularities on income and investment in the data. The ...
Staff Report , Paper 204

Working Paper
Expectation traps and monetary policy

Why is it that inflation is persistently high in some periods and persistently low in other periods? We argue that lack of commitment in monetary policy may bear a large part of the blame. We show that, in a standard equilibrium model, absence of commitment leads to multiple equilibria, or expectation traps. In these traps, expectations of high or low inflation lead the public to take defensive actions which then make it optimal for the monetary authority to validate those expectations. We find support in cross-country evidence for key implications of the model.
Working Paper Series , Paper WP-02-04

Labor contracts in a model of imperfect competition

We propose a definition of involuntary unemployment which differs from that traditionally used in implicit labor contract theory. We say that a worker is involuntarily unemployed if the marginal wage implied by the optimal contract exceeds the marginal rate of substitution between leisure and consumption. We construct a model where risk-neutral firms have monopoly power and show that such monopoly power is necessary for involuntary unemployment to arise in the optimal contract. We numerically compute examples and show that such unemployment occurs for a wide range of parameter values.
Staff Report , Paper 117


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