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Distortionary Taxation, Debt, and the Price Level

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  • A. Schabert

    (University of Amsterdam)

  • L. v. Thadden

    (European Central Bank)

Abstract

This paper considers the nominal and real determinacy of equilibria under an exogenously specified path of interest rates in an economy in which taxation is either lump-sum or distortionary. Under lump-sum taxation, we confirm the well-known finding that equilibria display nominal (in)determinacy if the primary surplus is exogenous (endogenous). Under distortionary taxation, this classification is no longer relevant. Nominal determinacy is always ensured since distortionary taxes establish a link between the allocation and the sequences of taxes and debt and, hence, the price level, regardless of whether the primary surplus is exogenous or endogenous. Distortionary taxation, however, increases the scope for real indeterminacy. As a general feature, the real (in)determinacy of equilibria depends on the interaction of fiscal and monetary policies, i.e. on the sequences of taxes, debt, and interest rates. If, for example, fiscal policy runs a balanced budget the central bank should set the nominal interest rate in a way consistent with long-run deflation in order to ensure real determinacy. This finding is different from a balanced-budget policy under lump-sum taxes where no such qualification with respect to the interest rate needs to be made

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 75.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:75

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Keywords: Monetary and fiscal policy; Distortionary taxes; Price level determination; Balanced budget policy;

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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2000. "Price level determinacy and monetary policy under a balanced-budget requirement," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 211-246, February.
  2. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  3. Eric Leeper & Tack Yun, 2006. "Monetary-fiscal policy interactions and the price level:Background and beyond," International Tax and Public Finance, Springer, vol. 13(4), pages 373-409, August.
  4. Bassetto, Marco & Kocherlakota, Narayana, 2004. "On the irrelevance of government debt when taxes are distortionary," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 299-304, March.
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  7. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "Monetary Policy and Multiple Equilibria," CEPR Discussion Papers 2316, C.E.P.R. Discussion Papers.
  8. Benigno, Pierpaolo & Woodford, Michael, 2004. "Optimal monetary and fiscal policy: a linear-quadratic approach," Working Paper Series 0345, European Central Bank.
  9. Niepelt, Dirk, 2002. "The Fiscal Myth of the Price Level," Seminar Papers 710, Stockholm University, Institute for International Economic Studies.
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Cited by:
  1. Bai, Yuting & Kirsanova, Tatiana, 2013. "Infrequent Fiscal Stabilization," SIRE Discussion Papers 2013-17, Scottish Institute for Research in Economics (SIRE).
  2. Andreas Schabert, 2009. "Monetary Policy under a Fiscal Theory of Sovereign Default," Tinbergen Institute Discussion Papers 09-093/2, Tinbergen Institute.
  3. Andreas Schabert, 2009. "Monetary Policy under a Fiscal Theory of Sovereign Default," Tinbergen Institute Discussion Papers 09-093/2, Tinbergen Institute.

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