Optimal policy with general signal extraction

Scholarly Edition

Most available results on optimal decisions under partial information are derived under “separation”. But this principle does not always hold. We derive a non-standard first order condition of optimality from first principles when signal extraction and optimal policy must be jointly determined. This allows us to solve a model of optimal fiscal policy where separation does not apply. Tax smoothing prevails in normal times, but taxes respond strongly in recessions. This non-linearity arises because signal extraction interacts differently with optimal policy depending on the value of the observed signals. Existing results based on the “separation principle” follow as special cases.

Full Text

Duke Authors

Cited Authors

  • Hauk, E; Lanteri, A; Marcet, A

Published Date

  • March 1, 2021

Start / End Page

  • 54 - 86

Digital Object Identifier (DOI)

  • 10.1016/j.jmoneco.2021.01.002

Citation Source

  • Scopus