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Author:Chugh, Sanjay K. 

Working Paper
Optimal fiscal and monetary policy when money is essential

We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. Our main results are in stark contrast to the prescriptions of earlier flexible-price Ramsey models. Two especially important findings emerge from our work: the Friedman Rule is typically not optimal and inflation is stable over time. Inflation is not a substitute instrument for a missing tax, as is sometimes the case in standard Ramsey models. Rather, the inflation tax is exactly the right tax to use ...
International Finance Discussion Papers , Paper 880

Working Paper
Optimal fiscal and monetary policy with costly wage bargaining

Costly nominal wage adjustment has received renewed attention in the design of optimal policy. In this paper, we embed costly nominal wage adjustment into the modern theory of frictional labor markets to study optimal fiscal and monetary policy. Our main result is that the optimal rate of price inflation is highly volatile over time despite the presence of sticky nominal wages. This finding contrasts with results obtained using standard sticky-wage models, which employ Walrasian labor markets at their core. The presence of shared rents associated with the formation of long-term employment ...
International Finance Discussion Papers , Paper 893

Working Paper
Does monetary policy keep up with the Joneses? Optimal interest-rate smoothing with consumption externalities

Changes in monetary policy are typically implemented gradually, an empirical observation known as interest-rate smoothing. We propose the explanation that time-non-separable preferences may render interest-rate smoothing optimal. We find that when consumers have "catching-up-with-the-Joneses" preferences, optimal monetary policy reacts gradually to shocks to prevent inefficiently fast adjustments in consumption. We also extend our basic model to investigate the effects of capital formation and nominal rigidities on the dynamics of optimal monetary policy. Optimal policy responses continue ...
International Finance Discussion Papers , Paper 812

Working Paper
Tax smoothing in frictional labor markets

We re-examine the optimality of tax smoothing from the point of view of frictional labor markets. Our central result is that whether or not this cornerstone optimal fiscal policy prescription carries over to an environment with labor market frictions depends crucially on the cyclical nature of labor force participation. If the participation rate is exogenous at business-cycle frequencies -- as is typically assumed in the literature -- we show it is not optimal to smooth tax rates on labor income in the face of business-cycle shocks. However, if households do optimize at the participation ...
International Finance Discussion Papers , Paper 965

Working Paper
Optimal fiscal and monetary policy in customer markets

A growing body of evidence suggests that ongoing relationships between consumers and firms may be important for understanding price dynamics. We investigate whether the existence of such customer relationships has important consequences for the conduct of both long-run and short-run policy. Our central result is that when consumers and firms are engaged in long-term relationships, the optimal rate of price inflation volatility is very low even though all prices are completely flexible. This finding is in contrast to those obtained in first-generation Ramsey models of optimal fiscal and ...
International Finance Discussion Papers , Paper 919

Working Paper
Optimal inflation persistence: Ramsey taxation with capital and habits

Ramsey models of fiscal and monetary policy with perfectly-competitive product markets and a fixed supply of capital predict highly volatile inflation with no serial correlation. In this paper, we show that an otherwise-standard Ramsey model that incorporates capital accumulation and habit persistence predicts highly persistent inflation. The result depends on increases in either the ability to smooth consumption or the preference for doing so. The effect operates through the Fisher relationship: a smoother profile of consumption implies a more persistent real interest rate, which in turn ...
International Finance Discussion Papers , Paper 829

Working Paper
Competitive search equilibrium in a DSGE model

We show how to implement a competitive search equilibrium in a fully-specified DSGE environment. Competitive search, an equilibrium concept well-understood in labor market theory, offers an alternative to the commonly-used Nash bargaining in search-based macro models. Our simulation-based results show that business cycle fluctuations under competitive search equilibrium are virtually identical to those under Nash bargaining for a broad range of calibrations of Nash bargaining power. We also prove that business cycle fluctuations under competitive search equilibrium are exactly identical to ...
International Finance Discussion Papers , Paper 929

Working Paper
Bargaining, fairness, and price rigidity in a DSGE environment

A growing body of evidence suggests that an important reason why firms do not change prices nearly as much as standard theory predicts is out of concern for disrupting ongoing customer relationships because price changes may be viewed as "unfair". Existing models that try to capture this concern regarding price-setting are all based on goods markets that are fundamentally Walrasian. In Walrasian goods markets, transactions are spot, making the idea of ongoing customer relationships somewhat difficult to understand. We develop a simple dynamic general equilibrium model of a search-based ...
International Finance Discussion Papers , Paper 900

Working Paper
Optimal fiscal and monetary policy with sticky wages and sticky prices

We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominal riskless debt, and money creation. One main result is that sticky wages alone make price stability optimal in the face of government spending shocks, to a degree quantitatively similar as sticky prices alone. With productivity shocks also present, optimal ...
International Finance Discussion Papers , Paper 834

Working Paper
Ramsey meets Hosios: the optimal capital tax and labor market efficiency

Heterogeneity between unemployed and employed individuals matters for optimal fiscal policy. This paper considers the consequences of welfare heterogeneity between these two groups for the determination of optimal capital and labor income taxes in a model with matching frictions in the labor market. In line with a recent finding in the literature, we find that the optimal capital tax is typically non-zero because it is used to indirectly mitigate an externality along the extensive labor margin that arises from search and matching frictions. However, the consideration of heterogeneity makes ...
International Finance Discussion Papers , Paper 870

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