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Control of the Public Debt: A Requirement for Price Stability?

  • Michael Woodford

The paper considers the role of limits upon the permissible growth of public debt, like those stipulated in the Maastricht treaty, in making price stability possible. It is shown that a certain type of fiscal instability, namely variations in the present value of current and future primary government budgets, necessarily results in price level instability, in the sense that there exists no possible monetary policy that results in an equilibrium with stable prices. In the presence of sluggish price adjustment, the fiscal shocks disturb real output and real interest rates as well. On the other hand, shocks of this kind can be eliminated by a Maastricht-type limit on the value of the public debt. In the presence of the debt limit (and under assumptions of frictionless financial markets, etc.), Ricardian equivalence holds, and fiscal shocks have no effects upon real or nominal variables. Furthermore, an appropriate monetary policy rule can ensure price stability even in the face of other kinds of real shocks. Thus the debt limit serves as a precondition for the common central bank in a monetary union to be charged with responsibility for maintaining a stable value for the common currency.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5684.

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Date of creation: Jul 1996
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Publication status: published as The Debt Burden and Monetary Policy, Calvo, G. and M. King, eds., London: MacMillan, 1997.
Handle: RePEc:nbr:nberwo:5684
Note: EFG ME
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  1. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  2. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  3. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  4. Uctum, Merih & Wickens, Michael R., 1997. "Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: An Intertemporal Analysis," CEPR Discussion Papers 1612, C.E.P.R. Discussion Papers.
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  8. Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
  9. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc.
  10. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  11. Buiter, Willem H. & Corsetti, Giancarlo & Roubini, Nouriel, 1992. "`Excessive Deficits': Sense and Nonsense in the Treaty of Maastricht," CEPR Discussion Papers 750, C.E.P.R. Discussion Papers.
  12. Svensson, Lars E O, 1986. "Sticky Goods Prices, Flexible Asset Prices, Monopolistic Competition, and Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 53(3), pages 385-405, July.
  13. Miles S. Kimball, 1995. "The Quantitative Analytics of the Basic Neomonetarist Model," NBER Working Papers 5046, National Bureau of Economic Research, Inc.
  14. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
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  18. repec:cup:cbooks:9780521558839 is not listed on IDEAS
  19. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  20. 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.
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