The combination of discretionary monetary policy, labour-market distortions and nominal wage rigidity yields an inflation bias as monetary policy tries to exploit nominal wage contracts to address labour-market distortions. Although an inflation target eliminates this inflation bias, it creates...

We study fiscal devaluation in a small-open economy with labor market search frictions. Our analysis shows the key role of both dimensions in shaping the optimal tax scheme. By reducing labor market distortions, the tax reform is welfare-improving. Yet, as it makes imports more expensive, fiscal...