Fiscal policy and optimal, monetary rules in a non-Ricardian economy

We study in this article how the conduct of fiscal policy interacts with the choice of optimal monetary rules by a central bank. We consider a non-Ricardian model with nondistortionary fiscal policies, and compare two policy packages, one where fiscal and monetary policies are simultaneously optimized, and one where monetary policy is optimized under a given fiscal policy. We find a number of results that would not appear in the traditional Ricardian framework: (a) the optimal monetary rule may be activist when fiscal policy is kept inactive, whereas it is not when combined with optimal fiscal policy; (b) combining optimally fiscal and monetary policies may lead to far superior outcomes, even when, following Sargent and Wallace (1975, Journal of Political Economy 83, 241-254), government is allowed. to react to much less information. (C) 2003 Elsevier Science (USA). All rights reserved.