ECB Working Paper Series - No. 345 - Optimal Monetary and Fiscal Policy - A Linear-Quadratic Approach

Sep 18, 2026

Uploaded by Jacob

We propose an integrated treatment of optimal monetary and fiscal policy in an economy with sticky prices and only distorting tax revenues. A linear-quadratic approach nests conventional monetary stabilization analysis and optimal tax-smoothing as special cases within a unified framework. The paper derives a linear-quadratic policy problem that delivers a correct linear approximation to optimal policy rules in a dynamic stochastic general-equilibrium setting based on expected discounted utility maximization. Targeting rules are then derived for implementing the optimal equilibrium.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages83

Reading Time3 h 29 min

AccessFree to download

Abstract

Non-technical summary

Introduction

The policy problem

A linear-quadratic approximate problem

Optimal responses to shocks

The case of flexible prices

The case of sticky prices

Optimal targeting rules for monetary and fiscal policy

Conclusion

Appendix

WORKING PAPER SERIES NO . 345 / APRIL 2004 INTERNATIONAL RESEARCH FORUM ON MONETARY POLICY OPTIMAL MONETARY AND FISCAL POLICY A LINEAR-QUADRATIC APPROACH by Pierpaolo Benigno and Michael Woodford In 2004 all publications will carry a motif taken from the €100 banknote. WORKING PAPER SERIES NO . 345 / APRIL 2004 INTERNATIONAL RESEARCH FORUM ON MONETARY POLICY OPTIMAL MONETARY AND FISCAL POLICY A LINEAR-QUADRATIC APPROACH 1 by Pierpaolo Benigno 2 and Michael Woodford 3 This paper can be downloaded without charge from [http://www.ecb.int](http://www.ecb.int) or from the Social Science Research Network electronic library at [http://ssrn.com/abstract_id=532988](http://ssrn.com/abstract_id=532988) . 1 Published in Mark Gertler and Kenneth Rogo®, eds., NBER Macroeconomics Annual 2003, Cambridge: MIT Press, [http://mitpress.mit.edu](http://mitpress.mit.edu). Reprinted with permission of The MIT Press. We would like to thank Stefania Albanesi, MariosAngeletos, Albert Marcet, Ramon Marimon, seminar participants at New York University, Rutgers University, Universitat Pompeu Fabra, the NBER Macroeconomics Annual conference, and the editors for helpful comments, Brad Strum and Vasco Curdia for research assistance, and the National Science Foundation for research support through a grant to the NBER. 2 New York University, Department of Economics, 269 Mercer Street, New York, NY 10003, USA; [e-mail: pierpaolo.benigno@nyu.edu](e-mail: pierpaolo.benigno@nyu.edu) 3 Columbia University, Department of Economics, 420 W. 118th Street, New York, NY 10027, USA; [e-mail: mw2230@columbia.edu](e-mail: mw2230@columbia.edu) International Research Forum on Monetary Policy The International Research Forum on Monetary Policy is an initiative organised and sponsored by the European Central Bank, the Board of Governors ofthe Federal Reserve System, the Center for German and European Studies at Georgetown University and the Center for Financial Studies at Goethe University. The aim of the Forum is to foster discussion on new research on monetary policy issues that are relevant from a global perspective. The Forum organises regular conferences at locations alternating between the euro area and the United States. The first one took place at the ECB on 5 and 6 July 2002. The second took place at the Board of Governors ofthe Federal Reserve System in Washington on 14 and 15 November 2003. The issues (336-345) of the ECB Working Paper Series contain the papers presented on that occasion; the programme of the conference and the invited discussions can be accessed at [http://www.ecb.int/events/conf/intforum/intforum2.htm](http://www.ecb.int/events/conf/intforum/intforum2.htm) [Editorial assistance in preparing the papers was provided by Susana Sommaggio.](Editorial assistance in preparing the papers was provided by Susana Sommaggio.) © European Central Bank, 2004 Address Kaiserstrasse 29 60311 Frankfurt am Main, Germany Postal address Postfach 16 03 19 60066 Frankfurt am Main, Germany Telephone +49 69 1344 0 Internet [http://www.ecb.int](http://www.ecb.int) Fax +49 69 1344 6000 Telex 411 144 ecb d All rights reserved. Reproduction for educational and noncommercial purposes is permitted provided that the source is acknowledged. The views expressed in this paper do not necessarily reflect those of the European Central Bank. The statement of purpose for the ECB Working Paper Series is availablefrom the ECB website, [http://www.ecb.int](http://www.ecb.int). ISSN 1561-0810 (print) ISSN 1725-2806 (online) CONTENTS Abstract 4 Non-technical summary 5 1 Introduction 7 2 The policy problem 9 3 A linear-quadratic approximate problem 17 4 Optimal responses to shocks: The case of flexible prices 26 5 Optimal responses to shocks: The case of sticky prices 32 6 Optimal targeting rules for monetary and fiscal policy 40 7 Conclusion 45 A Appendix 48 A.1 Derivation of the a

FAQs

What is the paper’s main objective regarding monetary and fiscal policy?

It integrates the problem of optimal monetary and fiscal policy under sticky prices and distorting tax revenue, aiming to characterize the optimal policy rules and their implementation.

How does the linear-quadratic approach contribute to the analysis?

It provides a unified framework that nests conventional monetary stabilization and tax-smoothing results as special cases, enabling derivation of policy rules using a correct linear approximation.

What is required to implement the optimal equilibrium according to the paper?

The paper derives targeting rules so that the monetary and fiscal authorities can implement the optimal equilibrium in the stated model.

Sep 18, 2026

Uploaded by Jacob