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The Time Consistency of Monetary and Fiscal Policies

Working Paper 616 | Revised April 1, 2002

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The Time Consistency of Monetary and Fiscal Policies

Abstract

Are optimal monetary and fiscal policies time consistent in a monetary economy? Yes, but if and only if under commitment the Friedman rule of setting nominal interest rates to zero is optimal. This result is of applied interest because the Friedman rule is optimal for the standard preferences used in applied work, those consistent with the growth facts.