Optimal Fiscal and Monetary Policy: Equivalence Results

Abstract

In this paper, we analyze the implications of price setting restrictions for the conduct of cyclical fiscal and monetary policy. We consider an environment with monopolistic competitive firms, a shopping time technology, prices set one period in advance, and government expenditures that must be financed with distortionary taxes. We show that the sets of (frontier) implementable allocations are the same indepedendently of the degree of price stickiness. Furthermore, the sets of policies that decentralize each allocation are also the same except in the extreme cases of flexible and sticky prices, where the sets are larger.

Keywords: Optimal fiscal and monetary policy, sticky prices

JEL Classification: E31, E40, E52, E58, E62, E63