We describe a simple mechanism that generates inflation persistence in a standard sticky-price model of optimal fiscal and monetary policy. Key to this mechanism is that policies are implemented under discretion. The government's discretionary incentive to erode the real value of nominal public...

This paper studies optimal fiscal and monetary policy in a stochastic economy with imperfectly competitive product markets and a discretionary government. We find that, in the flexible price economy, optimal time-consistent policy implements the Friedman rule independently of the degree of...

We examine the dynamic properties of inflation in a model of optimal discretionary fiscal and monetary policies. The lack of commitment and the presence of nominally risk-free debt provide the government with an incentive to implement policies which induce positive and persistent inflation...