Simple Monetary-fiscal Targeting Rules

The authors analyze the characteristics of optimal dynamics in an economy in which neither prices nor wages adjust instantaneously and lump-sum taxes are unavailable as a source of government finance. They then propose that monetary and fiscal policy should be coordinated to satisfy a pair of simple specific targeting rules, a rule for (wage) inflation and a relationship that links the growth of real wages to past price and wage developments, and output gap dynamics. They show that such simple rule-based conduct of policy can do remarkably well in replicating the dynamics of the economy under optimal policy following a given shock.