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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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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
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  1. 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.
  2. 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.
  3. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco.
  4. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
  5. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  6. Uribe, Martin, 2006. "A fiscal theory of sovereign risk," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1857-1875, November.
  7. 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.
  8. 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.
  9. repec:oup:qjecon:v:119:y:2004:i:1:p:276-299 is not listed on IDEAS
  10. 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.
  11. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
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