On the time inconsistency of optimal monetary and fiscal policies with many consumer goods

This paper studies optimal monetary and fiscal policies in an economy à la Lucas and Stokey (1983) and Lagos and Wright (2005) with multiple cash and credit goods. We show that optimal policies are in general time inconsistent due to insufficient number of instruments to influence future government decisions. There are two important cases where time consistency can be restored. First, if taxes in the decentralized anonymous markets are not available, the multipliers on the decentralization constraints can be utilized as additional instruments to ensure time consistency. Second, if taxes in decentralized markets are available, time consistency arises when the different cash goods satisfy the conditions necessary for optimal uniform taxation. optimal policy ; time consistency ; taxation ; money ; inflation ; search