MACROECONOMIC EXTERNALITIES - ARE PIGOUVIAN TAXES THE ANSWER

Basic welfare economics tells us that many types of externalities can be remedied by proper use of corrective taxes and subsidies. This pape r shows that this notion also extends to the macroeconomic externaliti es discussed in recent Keynesian literature on nominal price rigiditie s. The derived policy rules are kindred in spirit to standard Keynesia n policy prescriptions: progressive taxes may serve a useful role in c ombating wasteful economic fluctuations. However, unlike older fix-pri ce models of automatic stabilizers, progressive taxes work in our mono polistic economy because they directly affect the pricing mechanism