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The Conduct of Monetary Policy with a Shrinking Stock of Government Debt

  • Schreft, Stacey L
  • Smith, Bruce D

This article considers the consequences for a central bank of a declining stock of government debt. The model has a treasury that taxes, spends, and issues debt; a central bank that conducts open market operations in treasury debt; and banks that intermediate private savings. It suggests that a sufficiently small stock of debt can put an economy on the Pareto inferior side of the seigniorage Laffer curve, implying unnecessarily high inflation. If there is also a primary budget deficit, equilibrium might not exist. Discount-window lending is a potentially desirable alternative to open market operations, especially if the loans are not subsidized.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 34 (2002)
Issue (Month): 3 (August)
Pages: 848-82

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Handle: RePEc:mcb:jmoncb:v:34:y:2002:i:3:p:848-82
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  2. Smith, B.D., 1988. "Interest On Reserves And Sunspot Equilibria: Friedman'S Proposal Reconsidered," RCER Working Papers 119, University of Rochester - Center for Economic Research (RCER).
  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  4. Bhattacharya, Joydeep & Guzman, Mark G. & Smith, Bruce D., 1998. "Some Even More Unpleasant Monetarist Arithmetic," Staff General Research Papers 5084, Iowa State University, Department of Economics.
  5. Greenwood, J. & Smith, B.D., 1995. "Financial Markets in Development, and the Development of Financial Markets," RCER Working Papers 406, University of Rochester - Center for Economic Research (RCER).
  6. Stacey L. Schreft & Bruce D. Smith, 1997. "The evolution of cash transactions: some implications for monetary policy," Financial Services working paper 97-04, Federal Reserve Bank of Cleveland.
  7. Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
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