Tax Inefficiency, Public Debt Stabilization, and Monetary Policy Arrangements in Emerging Economics

Public debt stabilization has been considered important in the recent trend of institutional reforms of monetary arrangements in emerging economies. One crucial issue separating emerging from developed economies is that emerging economies often face serious inefficiency associated with tax collection, such as corruption, reducing the capability of controlling the primary budget balance as well as the entire public debt. This paper studies the relationship between tax-related inefficiency and public debt stabilization under two designs of monetary policies: inflation targeting and discretionary monetary arrangements. The result is that such inefficiency not only induces a higher level of public debt in the steady state but also reduces the adjustment speed for public debt stabilization, irrespective of monetary arrangements. This study also shows that the discretionary monetary arrangement enhances the adjustment speed for public debt more effectively, but which monetary arrangement is more effective in reducing the long-run level of public debt is highly dependent on the degree of tax-related inefficiency. In particular, the discretionary monetary arrangement could induce a higher level of public debt compared to the inflation targeting arrangement when the degree of tax-related inefficiency is either small or large enough.