DP3713 Optimal and Time-Consistent Monetary and Fiscal Policy with Heterogeneous Agents

Author(s): Stefania Albanesi

Publication Date: January 2003

Keyword(s): inflation , redistribution , heterogeneity , time consistency

JEL(s): E40 , E50 , E60

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP3713.asp

This Paper studies the structure and time consistency of optimal monetary policy from a public finance perspective in an economy where agents differ in transaction patterns and asset holdings. I find that heterogeneity breaks the link between lack of government commitment and high inflation, which characterizes representative agent models of optimal fiscal and monetary policy. Even under commitment, it may be optimal to depart from Friedman’s rule for setting nominal interest rates. Moreover, optimal monetary and fiscal policies are time consistent. Time consistency does not require outstanding nominal claims on the government to be zero.