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Monetary policy and liquid government debt

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  • Andolfatto, David
  • Martin, Fernando M.

Abstract

We examine the conduct of monetary policy in a world where the supply of outside money is controlled by the fiscal authority–a scenario increasingly relevant for many developed economies today. Central bank control over the long-run inflation rate depends on whether fiscal policy is Ricardian or Non-Ricardian. The optimal monetary policy follows a generalized Friedman rule that eliminates the liquidity premium on scarce treasury debt. We derive conditions for determinacy under both fiscal regimes and show that they do not necessarily correspond to the Taylor principle. In addition, Non-Ricardian regimes may suffer from multiplicity of steady-states when the government runs persistent deficits.

Suggested Citation

  • Andolfatto, David & Martin, Fernando M., 2018. "Monetary policy and liquid government debt," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 183-199.
  • Handle: RePEc:eee:dyncon:v:89:y:2018:i:c:p:183-199
    DOI: 10.1016/j.jedc.2018.01.037
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    References listed on IDEAS

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    1. Martin, Fernando M., 2016. "The Value of Constraints on Discretionary Government Policy," Working Papers 2016-19, Federal Reserve Bank of St. Louis, revised 15 Feb 2017.
    2. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
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    Cited by:

    1. Andolfatto, David & Spewak, Andrew, 2018. "Understanding Lowflation," Working Papers 2018-24, Federal Reserve Bank of St. Louis.
    2. repec:eee:dyncon:v:89:y:2018:i:c:p:173-182 is not listed on IDEAS
    3. Andolfatto, David, 2018. "Assessing the Impact of Central Bank Digital Currency on Private Banks," Working Papers 2018-25, Federal Reserve Bank of St. Louis, revised 06 Oct 2018.
    4. repec:gam:jsusta:v:10:y:2018:i:6:p:1834-:d:150208 is not listed on IDEAS
    5. Berentsen, Aleksander & Waller, Christopher, 2018. "Liquidity premiums on government debt and the fiscal theory of the price level," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 173-182.

    More about this item

    Keywords

    Monetary policy; Inflation; Taylor rule; Determinacy; Ricardian; Liquid bonds;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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