Monetary rules and fiscal feedback rules

Based on a Cobb–Douglas social welfare function in terms of the utilities of two concurrent generations, this paper derives a Pareto-efficient, envy-free, and equitable interest rate rule supported by a nonlinear-tax feedback rule in case of steady-state disturbance. The young are taxed to subsidize the elderly, expecting the same treatment when the young become old; hence, fiscal policy matters as much as the monetary policy does with regard to the “same”. The emphasis on monetary policy lies rather in the fact that once the equilibrium status quo of a policy accommodative of a given tax subsidy-cum-interest rate scheme is disturbed, the “interest-rate part” will continue being a sensible policy choice only by manipulating the “tax-subsidy part”. From the political economy view of tax nonlinearity, the tax policy under instability is expected to be both a self-confirming and a perfect insight majority rule equilibrium.