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POLICY GAMES, DISTRIBUTIONAL CONFLICTS, AND THE OPTIMAL INFLATION

Published online by Cambridge University Press:  11 August 2014

Alice Albonico  and
Lorenza Rossi
Alice Albonico*
Affiliation:
University of Milan Bicocca
Lorenza Rossi
Affiliation:
University of Pavia
*
Address correspondence to: Alice Albonico, Department of Economics, Management and Statistics, Piazza Ateneo Nuovo 1, 20126 Milan, Italy; e-mail: alice.albonico@unimib.it.
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Abstract

This paper shows that limited asset-market participation (LAMP) generates an extra inflation bias when the fiscal and the monetary authority play strategically. A fully redistributive fiscal policy eliminates the extra inflation bias, but at the cost of reducing Ricardians' welfare. A fiscal authority that redistributes income only partially reduces the inflation bias, but raises government spending. Although a fully conservative monetary policy is necessary to get price stability, it implies a reduction in liquidity-constrained consumers' welfare, in the absence of redistributive fiscal policies. Finally, under a crisis scenario, none of the policy regimes is able to avoid the fall in economic activity when the increase in the fraction of LAMP is coupled with a negative technology shock, whereas optimal policy can avoid recession when it responds to the increase in LAMP proportion alone.

Keywords

Limited Asset Market ParticipationOptimal Monetary and Fiscal PolicyStrategic InteractionInflation BiasRedistribution
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Special Issue 6: Growth, Optimal Fiscal and Monetary Policy, and Financial Frictions , September 2015 , pp. 1261 - 1293
Copyright
Copyright © Cambridge University Press 2014 

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