The conduct of monetary policy with a shrinking stock of government debt
In many countries, government-budget surpluses have led to a decline in the amount of federal government debt outstanding. This paper considers the consequences of this development for a central bank that conducts monetary policy through open market operations in treasury debt. A model is presented in which a treasury taxes, spends, and issues debt; a central bank conducts monetary policy through open market operations; and banks are intermediaries for all private savings. The model suggests potentially severe consequences from a shrinking stock of government debt in the absence of a change in the conduct of monetary policy. Specifically, the nominal interest rate and the inflation rate cannot be below their seigniorage-maximizing levels. In effect, a small stock of debt combined with restrictions on a central bank’s portfolio can put the economy on the Pareto inferior side of the seigniorage Laffer curve, with an unnecessarily high inflation rate and nominal interest rate. Moreover, if the government also runs a primary budget deficit, equilibrium can fail to exist. The model presented can yield estimates of how much debt must be outstanding to avoid each situation. Discount-window lending is a feasible—and desirable— alternative method for conducting monetary policy. It relaxes any restrictions on the attainable set of interest rates and inflation rates implied by a decline in the stock of government debt outstanding. Unless the economy is on the Pareto inferior side of the Laffer curve, welfare is higher when discount-window loans are made at market-determined interest rates.
|Date of creation:||2001|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: (816) 881-2254
Web page: http://www.kansascityfed.org/
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Greenwood, Jeremy & Smith, Bruce D., 1997.
"Financial markets in development, and the development of financial markets,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 21(1), pages 145-181, January.
- 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).
- Smith, Bruce D, 1994. "Efficiency and Determinacy of Equilibrium under Inflation Targeting," Economic Theory, Springer, vol. 4(3), pages 327-44.
- 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.
- 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.
- Schreft, Stacey L. & Smith, Bruce D., 2000. "The evolution of cash transactions: Some implications for monetary policy," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 97-120, August.
- Stacey L. Schreft & Bruce D. Smith, 1999. "The evolution of cash transactions : some implications for monetary policy," Research Working Paper 99-02, Federal Reserve Bank of Kansas City.
- 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).
- Smith, Bruce D, 1991. "Interest on Reserves and Sunspot Equilibria: Friedman's Proposal Reconsidered," Review of Economic Studies, Wiley Blackwell, vol. 58(1), pages 93-105, January.
- Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
When requesting a correction, please mention this item's handle: RePEc:fip:fedkrw:rwp01-09. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lu Dayrit)
If references are entirely missing, you can add them using this form.