Published online by Cambridge University Press: 19 July 2018
In this paper, we adopt a Ramsey optimal approach to identify the combination of income taxes, public expenditure, and inflation designed to achieve a fiscal consolidation. In contrast with empirical contributions that emphasize the benefits of expenditure-based consolidations, the optimal policy calls for increases in taxes and inflation. Strong monetary accommodation is quite beneficial relative to a situation where the Central Bank is only concerned with inflation stability and the inflation target is defined as a ceiling, as in the Eurozone.
R. Cardani and P. Tirelli gratefully acknowledge financial support from EC project 320278-RASTANEWS. We thank the anonymous referees, as well as participants at numerous conferences and seminars, for helpful comments and suggestions. The views expressed are those of the individual author and do not necessarily reflect official positions of Banco de Mexico.