Solving Boundary Value Problems in the Fiscal Theory of the Price Level
This paper specifi es determinacy regions in the parameter space of monetary and fiscal policy interactions in economies with finance and tax distortions. It shows that the initial valuation of government debt is the fixed point of a continuous mapping that takes a closed interval on the real line into itself. It implements the Krasnoselski-Mann-Baily theorem to compute the equilibrium real value of nominal government debt. This computation indicates whether policy interactions are sustainable or lead to a default. The model exhibits nominal determinacy if and only if it exhibits real determinacy. Distorting taxes have dramatic effect on determinacy regions. Admissible monetary- scal policy interactions vary as the economy approaches the peak of its Laffer curve: the range of active scal responses to government debt narrows,whereas passive fiscal stances become inconsistent with equilibrium. Furthermore, policy targets vary when regimes switch from passive fiscal stances to active fiscal stances. Whereas passive fiscal stances focus entirely on secondary defi cits, active fi scal stances should focus mainly on primary de ficits.
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