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The Sustainability of Budget Deficits in an Inflationary Economy

  • Harashima, Taiji

This paper examines fiscal sustainability in an inflationary environment, particularly the interrelation between government debt and inflation. A model that explicitly incorporates the political utility/objective function of government is constructed. The government’s borrowing behavior and inflation are determined through the simultaneous optimization of government and households. The sustainable fiscal debt in an inflationary environment was found to equal the present value of primary balances discounted by the time preference rate of government, not by the interest rate. This result raises the question of whether it is appropriate to apply the fiscal sustainability test of Hamilton and Flavin to high inflation countries.

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File URL: https://mpra.ub.uni-muenchen.de/1088/1/MPRA_paper_1088.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 905.

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Date of creation: 27 Nov 2006
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Handle: RePEc:pra:mprapa:905
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  1. Michael Woodford, 2001. "Fiscal Requirements for Price Stability," NBER Working Papers 8072, National Bureau of Economic Research, Inc.
  2. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," NBER Working Papers 6646, National Bureau of Economic Research, Inc.
  3. Hakkio, Craig S & Rush, Mark, 1991. "Is the Budget Deficit "Too Large?"," Economic Inquiry, Western Economic Association International, vol. 29(3), pages 429-45, July.
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  5. 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.
  6. Guido Tabellini & Alberto Alesina, 1988. "Voting on the Budget Deficit," UCLA Economics Working Papers 539, UCLA Department of Economics.
  7. James D. Hamilton & Marjorie A. Flavin, 1985. "On the Limitations of Government Borrowing: A Framework for Empirical Testing," NBER Working Papers 1632, National Bureau of Economic Research, Inc.
  8. Wilcox, David W, 1989. "The Sustainability of Government Deficits: Implications of the Present-Value Borrowing Constraint," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(3), pages 291-306, August.
  9. Shaghil Ahmed & John H. Rogers, 1995. "Government budget deficits and trade deficits: are present value constraints satisfied in long-term data?," International Finance Discussion Papers 494, Board of Governors of the Federal Reserve System (U.S.).
  10. Taiji Harashima, 2005. "The Cause of the Great Inflation: Interactions between the Government and the Monetary Policymakers," Macroeconomics 0510026, EconWPA, revised 31 Oct 2005.
  11. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the Fiscal Theory of the Price Level," NBER Working Papers 7668, National Bureau of Economic Research, Inc.
  12. Bharat Trehan & Carl E. Walsh, 1987. "Common trends, the government's budget constraint, and revenue smoothing," Working Papers in Applied Economic Theory 87-11, Federal Reserve Bank of San Francisco.
  13. Alberto Alesina & Alex Cukierman, 1987. "The Politics of Ambiguity," NBER Working Papers 2468, National Bureau of Economic Research, Inc.
  14. Karras, Georgios, 1994. "Macroeconomic effects of budget deficits: further international evidence," Journal of International Money and Finance, Elsevier, vol. 13(2), pages 190-210, April.
  15. Edwards, Jeremy & Keen, Michael, 1996. "Tax competition and Leviathan," European Economic Review, Elsevier, vol. 40(1), pages 113-134, January.
  16. John H. Cochrane, 2000. "Money as Stock: Price Level Determination with no Money Demand," NBER Working Papers 7498, National Bureau of Economic Research, Inc.
  17. Stanley Fischer & Ratna Sahay & Carlos A. Végh Gramont, 2002. "Modern Hyper- and High Inflations," IMF Working Papers 02/197, International Monetary Fund.
  18. Taiji Harashima, 2004. "The Ultimate Source of Inflation: A Microfoundation of the Fiscal Theory of the Price Level," Macroeconomics 0409018, EconWPA, revised 23 Sep 2004.
  19. Haug, Alfred A, 1991. "Cointegration and Government Borrowing Constraints: Evidence for the United States," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(1), pages 97-101, January.
  20. Willem H. Buiter, 2002. "The Fiscal Theory Of The Price Level: A Critique," Economic Journal, Royal Economic Society, vol. 112(481), pages 459-480, July.
  21. 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.
  22. Alesina, A. & Drazen, A., 1991. "Why Are Stabilizations Delayed?," Papers 6-91, Tel Aviv - the Sackler Institute of Economic Studies.
  23. Ali Darrat, 2000. "Are budget deficits inflationary? A reconsideration of the evidence," Applied Economics Letters, Taylor & Francis Journals, vol. 7(10), pages 633-636.
  24. Bohn, H., 1990. "The Sutainability Of Budget Deficits In A Stochastic Economy," Weiss Center Working Papers 6-90, Wharton School - Weiss Center for International Financial Research.
  25. Buiter, Willem H., 2004. "A Small Corner of Intertemporal Public Finance - New Developments in Monetary Economics: Two Ghosts, Two Eccentricities, a Fallacy, a Mirage and a Mythos," CEPR Discussion Papers 4407, C.E.P.R. Discussion Papers.
  26. Sims, Christopher A, 2001. "Fiscal Consequences for Mexico of Adopting the Dollar," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 597-616, May.
  27. Sims, Christopher A., 1998. "Econometric implications of the government budget constraint," Journal of Econometrics, Elsevier, vol. 83(1-2), pages 9-19.
  28. Narayana R. Kocherlakota & Christopher Phelan, 1999. "Explaining the fiscal theory of the price level," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-23.
  29. 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;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-99.
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