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Optimal monetary and fiscal policy with social status seeking and liquidity constraints

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  • Juin‐Jen Chang
  • Hsieh‐Yu Lin
  • Jhy‐Yuan Shieh

Abstract

We study the optimal monetary (nominal interest rate) and fiscal (income tax) policy with both consumption‐ and wealth‐induced status seeking under a generalized liquidity constraint on consumption and investment. Our results suggest that monetary policy, in general, has an advantage in correcting status‐seeking‐induced distortions. A simple policy mix is incapable of leading the optimal allocation to be decentralized in the presence of wealth‐based (consumption‐based) status seeking under the cash constraint on consumption (investment) only. As for sub‐optimal policies, the monetary policy follows Friedman's rule while the optimal income tax corrects the consumption‐induced externality, leaving the wealth‐induced externality uncorrected.

Suggested Citation

  • Juin‐Jen Chang & Hsieh‐Yu Lin & Jhy‐Yuan Shieh, 2021. "Optimal monetary and fiscal policy with social status seeking and liquidity constraints," International Journal of Economic Theory, The International Society for Economic Theory, vol. 17(2), pages 151-168, June.
    • Handle: RePEc:bla:ijethy:v:17:y:2021:i:2:p:151-168
    DOI: 10.1111/ijet.12220
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    References listed on IDEAS

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