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Active monetary policy, passive fiscal policy and the value of public debt: some further monetarist arithmetic

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  • von Thadden, Leopold

Abstract

We consider the properties of two monetary policy rules ("strict inflation targeting", "constant money growth rule") in an intertemporal equilibrium model with flexible prices in which monetary policy is "active", while fiscal policy is "passive". Specifically, we assume that the fiscal agent takes the monetary policy rule as given and restricts itself to a policy which is consistent with a sustainable debt burden and stable steady-state dynamics. The paper shows that dynamic properties of the model economy may differ significantly between the two monetary policy rules if public debt is issued in nominal terms. Under a constant money growth rule which allows for temporary deviations of inflation from target in response to shocks there is scope for revaluations of public debt, acting as automatic stabilizers of government debt dynamics. By contrast, a policy of strict inflation targeting implements the target inflation rate also outside the steady state and precludes thereby such stabilizing revaluations. Owing to this feature, additional fiscal restraint may be needed which is not required under a constant money growth rule.

Suggested Citation

  • von Thadden, Leopold, 2003. "Active monetary policy, passive fiscal policy and the value of public debt: some further monetarist arithmetic," Discussion Paper Series 1: Economic Studies 2003,12, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdp1:4209
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    Cited by:

    1. Kamal, Mona, 2010. "الإطار النظرى للتنسيق بين السياستين المالية والنقدية
      [The Theoretical Framework for the Coordination of Fiscal and Monetary Polices]
      ," MPRA Paper 26856, University Library of Munich, Germany.

    More about this item

    Keywords

    Monetary policy; Fiscal regimes; Overlapping generations;

    JEL classification:

    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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