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Monetary Policy under a Fiscal Theory of Sovereign Default

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  • Andreas Schabert

    (University of Amsterdam, and TU Dortmund University)

Abstract

This paper examines equilibrium determination under different monetary policy regimes when the government might default on its debt. We apply a cash-in-advance model where the government does not have access to non-distortionary taxation and does not account for initial outstanding debt when it sets the income tax rate. Solvency is then not guaranteed and sovereign default can affect the return on public debt. If the central bank sets the interest rate in a conventional way, the equilibrium allocation cannot be determined. If, instead, money supply is controlled, the equilibrium allocation can uniquely be determined.

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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 09-093/2.

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Date of creation: 06 Nov 2009
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Handle: RePEc:dgr:uvatin:20090093

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Web page: http://www.tinbergen.nl

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Keywords: Equilibrium determination; interest rate policy; money supply; public debt; sovereign default;

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  1. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  2. Benhabib, Jess & Eusepi, Stefano, 2005. "The design of monetary and fiscal policy: A global perspective," Journal of Economic Theory, Elsevier, vol. 123(1), pages 40-73, July.
  3. Niepelt, Dirk, 2002. "The Fiscal Myth of the Price Level," Seminar Papers 710, Stockholm University, Institute for International Economic Studies.
  4. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "Monetary Policy and Multiple Equilibria," CEPR Discussion Papers 2316, C.E.P.R. Discussion Papers.
  5. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  6. Martin Uribe, 2002. "A Fiscal Theory of Sovereign Risk," NBER Working Papers 9221, National Bureau of Economic Research, Inc.
  7. Andreas Schabert & Leopold Von Thadden, 2009. "Distortionary Taxation, Debt, and the Price Level," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(1), pages 159-188, 02.
  8. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  9. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  10. Michener, Ronald & Ravikumar, B., 1998. "Chaotic dynamics in a cash-in-advance economy," Journal of Economic Dynamics and Control, Elsevier, vol. 22(7), pages 1117-1137, May.
  11. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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Cited by:
  1. repec:wlu:lcerpa:wm0070 is not listed on IDEAS
  2. repec:dgr:uvatin:2009102 is not listed on IDEAS
  3. repec:dgr:uvatin:2011027 is not listed on IDEAS
  4. Christos Shiamptanis, 2014. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," LCERPA Working Papers lm0063, Laurier Centre for Economic Research and Policy Analysis, revised Jun 2014.
  5. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  6. Schabert, Andreas, 2011. "Exchange rate policy under sovereign default risk," Economics Letters, Elsevier, vol. 112(2), pages 179-181, August.
  7. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," Economic Papers, The Economic Society of Australia, vol. 30(1), pages 33-47, 03.
  8. Roland Döhrn & György Barabas & Heinz Gebhardt & Tobias Kitlinski & Martin Micheli & Torsten Schmidt & Simeon Vosen & Lina Zwick, 2012. "Die wirtschaftliche Entwicklung im Inland: Gedämpfte Expansion bei hohen Risiken," RWI Konjunkturbericht, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, pages 57, 09.
  9. Christos Shiamptanis, 2012. "Risk Assessment Under a Non-linear Fiscal Rule," Working Papers 038, Ryerson University, Department of Economics.
  10. Betty Daniel & Christos Shiamptanis, 2008. "Fiscal Risk in a Monetary Union," Discussion Papers 08-12, University at Albany, SUNY, Department of Economics.

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