This chapter tackles the problem of the stabilization policies of governments that emerge as responses to shocks on the economy. It describes the current trend of using microfounded models for policy analysis. It provides two examples of optimal policies with microfounded models: optimal seigniorage under uncertainty and the non-Walrasian “policy effectiveness” of Thomas Sargent and Neil Wallace. It looks into how government policy design avoids fiscal and monetary policies that create indeterminacies and therefore instability, and concentrates on monetary interest rate rules. It also highlights the Pigou effect and how the effect determines simple rules guaranteeing global determinacy.
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