TY - UNPB

T1 - Ramsey monetary and fiscal policy: the role of consumption taxation

AU - Motta, Giorgio

AU - Rossi, Raffaele

N1 - 2013-14

PY - 2013/11/25

Y1 - 2013/11/25

N2 - We study Ramsey monetary and fiscal policy in a small scale New Keynesianmodel where government spending has intrinsic value, public debt isstate-noncontingent and the fiscal authority is constrained by usingdistortive taxation. We show that Ramsey policy is remarkably altered whenconsumption taxation is considered as a source of government revenuesalongside or as an alternative to labour income taxes. First, we show thatthe optimal steady-state size of the public spending is, ceteris paribus,greater under consumption taxation than under labour income tax. We furthershow that adopting consumption taxation has enormous long run welfare gainsand that these gains are increasing in the level of outstanding public debt.These welfare gains are not limited to the steady-state, but they are alsopresent in the dynamic stochastic equilibrium. The reason is that thedynamic nature of consumption taxation enables the policy-maker to affectthe stochastic discount factor via modifications of the marginal utility ofconsumption. This extra wedge impacts on the pricing decisions of firms, andhence on inflation stabilization, and greatly improves welfare in thestochastic equilibrium.

AB - We study Ramsey monetary and fiscal policy in a small scale New Keynesianmodel where government spending has intrinsic value, public debt isstate-noncontingent and the fiscal authority is constrained by usingdistortive taxation. We show that Ramsey policy is remarkably altered whenconsumption taxation is considered as a source of government revenuesalongside or as an alternative to labour income taxes. First, we show thatthe optimal steady-state size of the public spending is, ceteris paribus,greater under consumption taxation than under labour income tax. We furthershow that adopting consumption taxation has enormous long run welfare gainsand that these gains are increasing in the level of outstanding public debt.These welfare gains are not limited to the steady-state, but they are alsopresent in the dynamic stochastic equilibrium. The reason is that thedynamic nature of consumption taxation enables the policy-maker to affectthe stochastic discount factor via modifications of the marginal utility ofconsumption. This extra wedge impacts on the pricing decisions of firms, andhence on inflation stabilization, and greatly improves welfare in thestochastic equilibrium.

M3 - Working paper

T3 - Economics Working Paper Series

BT - Ramsey monetary and fiscal policy: the role of consumption taxation

PB - Lancaster University, Department of Economics

ER -