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Monetary policy under a fiscal theory of sovereign default

  • Schabert, Andreas

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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File URL: http://www.sciencedirect.com/science/article/pii/S0022-0531(09)00129-X
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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 145 (2010)
Issue (Month): 2 (March)
Pages: 860-868

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Handle: RePEc:eee:jetheo:v:145:y:2010:i:2:p:860-868
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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  1. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "Monetary Policy and Multiple Equilibria," CEPR Discussion Papers 2316, C.E.P.R. Discussion Papers.
  2. 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.
  3. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
  4. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  5. Martin Uribe, 2002. "A Fiscal Theory of Sovereign Risk," NBER Working Papers 9221, National Bureau of Economic Research, Inc.
  6. 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;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-99.
  7. Schabert, Andreas & von Thadden, Leopold, 2006. "Distortionary taxation, debt, and the price level," Working Paper Series 0577, European Central Bank.
  8. 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.
  9. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), 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.
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