Organizational Learning and Optimal Fiscal and Monetary PolicyI

In this paper we study optimal fiscal and monetary policy in a standard monetary Ramsey model aug-mented with price stickiness and organizational learning-by-doing (LBD) mechanism in production tech-nology. Our main result is that optimal Ramsey inflation is very stable and persistent over the business cycle. While a dynamic link between current production and future productivity generates the inflation persistence, the real cost of price adjustment is the key for the very low volatility in optimal inflation. Both of these mechanisms work through the monopolistic firms ’ optimal pricing condition – namely the New Keynesian Philips Curve. A second important result is that optimal tax policy is counter-cyclical-tax rates fall during recession and rise during boom. This finding contrasts with pro-cyclical tax results obtained in standard sticky price Ramsey models. The basic intuition for the result is that in presence of learning-by-doing, the Ramsey planner finds it relatively costly to raise taxes in response to a negative technology shock. Higher taxes would reduce hours, output, and hence organizational capital which will magnify the shock further by reducing future productivity. Therefore, the planner would optimally lower taxes to raise the after tax return to work and minimize the effects of the shock. Finally, inflation, nom-inal interest rate, and labor income tax rates are relatively lower in our model as compared to models without learning-by-doing. This result is a direct consequence of a relatively lower markup generated by the presence of learning-by-doing in our model