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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
Phone: 972-4-8240086
Fax: 972-4-8240059
Web page: http://hevra.haifa.ac.il/econ/en/

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  1. Harald Uhlig & Mathias Trabandt, 2009. "How Far are We from the Slippery Slope? The Laffer Curve Revisited," Working Papers 2009-005, Becker Friedman Institute for Research In Economics.
  2. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January.
  3. Huixin Bi, 2010. "Sovereign Default Risk Premia, Fiscal Limits and Fiscal Policy," Caepr Working Papers 2010-007, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  4. Marco Bassetto, 2002. "A Game-Theoretic View of the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 70(6), pages 2167-2195, November.
  5. Todd Walker & Eric Leeper & Troy Davig, 2010. "Inflation and the Fiscal Limit," 2010 Meeting Papers 837, Society for Economic Dynamics.
  6. 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.
  7. 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.
  8. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1999. "Avoiding Liquidity Traps," Working Papers 99-21, C.V. Starr Center for Applied Economics, New York University.
  9. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," CRSP working papers 478, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  10. Thorsten Drautzburg & Harald Uhlig, 2011. "Fiscal stimulus and distortionary taxation," CQER Working Paper 2011-01, Federal Reserve Bank of Atlanta.
  11. Huixin Bi & Eric M. Leeper & Campbell Leith, 2012. "Uncertain Fiscal Consolidations," Working Papers 2012_03, Business School - Economics, University of Glasgow.
  12. Cochrane, John H., 2005. "Money as stock," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 501-528, April.
  13. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  14. 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.).
  15. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
  16. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," NBER Working Papers 16819, National Bureau of Economic Research, Inc.
  17. Davig, Troy & Leeper, Eric M. & Walker, Todd B., 2010. ""Unfunded liabilities" and uncertain fiscal financing," Journal of Monetary Economics, Elsevier, vol. 57(5), pages 600-619, July.
  18. Troy Davig & Eric M. Leeper, 2011. "Temporarily Unstable Government Debt and Inflation," NBER Working Papers 16799, National Bureau of Economic Research, Inc.
  19. 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.
  20. Trabandt, Mathias & Uhlig, Harald, 2011. "The Laffer curve revisited," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 305-327.
  21. Baruch Gliksberg, 2009. "Monetary policy and multiple equilibria with constrained investment and externalities," Economic Theory, Springer, vol. 41(3), pages 443-463, December.
  22. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  23. Rebelo, S. & Xie, D., 1996. "On the Optimality of Interest Rate Smoothing," RCER Working Papers 427, University of Rochester - Center for Economic Research (RCER).
  24. 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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