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Some Even More Unpleasant Monetarist Arithmetic

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  • Bhattacharya, Joydeep
  • Guzman, Mark G.
  • Smith, Bruce D.

Abstract

Does monetizing a deficit result in a higher or a lower rate of inflation than does bond financing the same deficit? Sargent and Wallace (1981) produced conditions under which bond finance leads to a higher rate of inflation than deficit monetization ("unpleasant monetarist arithmetic''). However, it has been argued that unpleasant arithmetic is unlikely to obtain in practice, as it requires a number of conditions to hold that are rarely satisfied empirically. We develop a model essentially identical to that of Sargent and Wallace, and modify it to allow for a simple type of financial intermediation that they exogenously precluded. In the presence of reserve requirements, unpleasant arithmetic arises even when the real rate of growth exceeds the real return on bonds. Moreover, under a very mild restriction on the interest elasticity of savings, there exists a unique equilibrium to which unpleasant arithmetic results necessarily apply. No "Laffer curve'' considerations arise. We also discuss various tensions that arise between determinacy and efficiency of monetary equilibria.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 5084.

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Date of creation: 01 Aug 1998
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Publication status: Published in Canadian Journal of Economics, August 1998, vol. 31 no. 3, pp. 596-623
Handle: RePEc:isu:genres:5084

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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Cited by:
  1. Stacey L. Schreft & Bruce D. Smith, 2001. "The conduct of monetary policy with a shrinking stock of government debt," Research Working Paper RWP 01-09, Federal Reserve Bank of Kansas City.
  2. Mark G. Guzman, 2006. "The impact of paying interest on reserves in the presence of government deficit financing," Economics & Management Discussion Papers em-dp2006-39, Henley Business School, Reading University.
  3. Marco Espinosa-Vega & Steven Russell, 2001. "Stability of steady states in a model of pleasant monetarist arithmetic," Working Paper 2001-20, Federal Reserve Bank of Atlanta.
  4. Stacey Schreft & Bruce Smith, 2008. "The social value of risk-free government debt," Annals of Finance, Springer, vol. 4(2), pages 131-155, March.
  5. repec:rdg:wpaper:em-dp2006-39 is not listed on IDEAS
  6. Fung, Michael K. Y. & Ho, Wai-Ming & Zhu, Lijing, 2000. "Stagflationary effect of government bond financing in the transforming Chinese economy: a general equilibrium analysis," Journal of Development Economics, Elsevier, vol. 61(1), pages 111-135, February.
  7. Cothren, Richard, 2006. "A model of optimal legal restrictions and open market operations," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 480-492, September.
  8. Bhattacharya, Joydeep & Haslag, Joseph, 1999. "Monetary Policy Arithmetic: Some Recent Contributions," Staff General Research Papers 10388, Iowa State University, Department of Economics.
  9. Marco A. Espinosa-Vega & Steven Russell, 1997. "History and theory of the NAIRU: a critical review," Economic Review, Federal Reserve Bank of Atlanta, issue Q 2, pages 4-25.
  10. Joseph H. Haslag & Joydeep Bhattacharya, 1999. "Seigniorage in a neoclassical economy: some computational results," Working Papers 9901, Federal Reserve Bank of Dallas.

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