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Monetary Policy and Fiscal Limits with No-Default

This paper discusses monetary and fiscal interactions in fiscal stress with no outright default. Two distortions prevail in the economy: income taxes and liquidity constraints. Possible obstructions to fiscal policy include: a ceiling on the equilibrium Debt-to-GDP ratio; zero elasticity of tax revenues; a political intolerance of rising tax rates; A Laffer curve emerges endogenously. In equilibrium, fiscal solvency is brought about through adjustments to the level of nominal prices. Three regimes achieve this goal: FC - an interaction of a fiscal rule that targets both output and public debt with a neutral monetary policy; FD - an interaction of a fiscal rule that targets the primary deficit with an active monetary policy; FDA - an interaction of an austere fiscal rule with a passive monetary policy.

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File URL: http://hevra.haifa.ac.il/econ/wp_files/wp201206.pdf
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Paper provided by University of Haifa, Department of Economics in its series Working Papers with number WP2012/6.

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Date of creation: 06 Aug 2012
Date of revision: 19 May 2013
Handle: RePEc:haf:huedwp:wp201206
Contact details of provider: Postal: Mount Carmel, Haifa, 31905, Israel
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Web page: http://hevra.haifa.ac.il/econ/en/

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  1. Huixin Bi & Eric M. Leeper & Campbell Leith, 2013. "Uncertain Fiscal Consolidations," Working Papers 13-26, Bank of Canada.
  2. 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.
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  4. Troy Davig & Eric M. Leeper & Todd B. Walker, 2010. "Inflation and the Fiscal Limit," NBER Working Papers 16495, National Bureau of Economic Research, Inc.
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  7. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "Monetary policy and multiple equilibria," Finance and Economics Discussion Series 1998-29, Board of Governors of the Federal Reserve System (U.S.).
  8. Trabandt, Mathias & Uhlig, Harald, 2006. "How Far Are We From the Slippery Slope? The Laffer Curve Revisited," CEPR Discussion Papers 5657, C.E.P.R. Discussion Papers.
  9. 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.
  10. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc.
  11. Huixin Bi, 2011. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," Working Papers 11-10, Bank of Canada.
  12. Troy Davig & Eric M. Leeper, 2011. "Temporarily Unstable Government Debt and Inflation," NBER Working Papers 16799, National Bureau of Economic Research, Inc.
  13. Thorsten Drautzburg & Harald Uhlig, 2011. "Fiscal stimulus and distortionary taxation," CQER Working Paper 2011-01, Federal Reserve Bank of Atlanta.
  14. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," NBER Working Papers 6771, National Bureau of Economic Research, Inc.
  15. Marco Bassetto, 2000. "A Game-Theoretic View of the Fiscal Theory of the Price Level," Econometric Society World Congress 2000 Contributed Papers 1492, Econometric Society.
  16. Troy Davig & Eric M. Leeper & Todd B. Walker, 2010. ""Unfunded Liabilities" and Uncertain Fiscal Financing," NBER Working Papers 15782, National Bureau of Economic Research, Inc.
  17. Rebelo, Sergio & Xie, Danyang, 1999. "On the optimality of interest rate smoothing," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 263-282, April.
  18. Cochrane, John H., 2011. "Understanding policy in the great recession: Some unpleasant fiscal arithmetic," European Economic Review, Elsevier, vol. 55(1), pages 2-30, January.
  19. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "The Perils of Taylor Rules," CEPR Discussion Papers 2314, C.E.P.R. Discussion Papers.
  20. Gliksberg, Baruch, 2013. "Solving Boundary Value Problems in the Fiscal Theory of the Price Level," Working Papers WP2013/2, University of Haifa, Department of Economics.
  21. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," NBER Working Papers 16819, National Bureau of Economic Research, Inc.
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  23. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
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