Fiscal Progressivity and the Time Consistency of Monetary Policy

Abstract This paper studies how progressive fiscal policy shapes monetary policy in a heterogeneous‐agent economy. Progressive labor taxation, though distortionary, can mitigate the inflation bias of monetary policy by redistributing income. I examine this commitment channel through the lens of political conflict. When agents vote on monetary and fiscal instruments, progressivity curbs inflation bias by creating distributional tensions: lower productivity agents support higher labor taxes to protect the value of money holdings and shift tax distortions toward higher productivity agents. Anticipating lower inflation, all agents ultimately prefer adopting a progressive fiscal system.