DP4782 | Welfare-Maximizing Operational Monetary and Tax Policy Rules

Author(s)

Publication Date

23/12/2004

JEL Code(s)

Keyword(s)

Programme Area(s)

Network(s)

Abstract

This Paper computes welfare-maximizing monetary and tax policy feedback rules, in a calibrated dynamic general equilibrium model with sticky prices. The government makes exogenous final good purchases, levies a proportional income tax, and issues nominal one-period bonds. A quadratic approximation method is used to solve the model, and to compute household welfare. Optimized policy has a strong anti-inflation stance and implies persistent fluctuations of the tax rate and of public debt. Very simple optimized policy rules, under which the interest rate just responds to inflation and the tax rate just responds to public debt, yield a welfare level very close to that generated by richer rules.