IDEAS home Printed from https://ideas.repec.org/p/zbw/bofrdp/rdp2002_014.html
   My bibliography  Save this paper

Effects of fiscal policy on the durability of low inflation regimes

Author

Listed:
  • Pohjola, Tapio

Abstract

This paper deals with the interaction of fiscal and monetary policy when the central bank is pursuing a price stability-oriented monetary policy.In particular, we study the durability of the price stability regime when public debt accumulates as a result of ultimately unsustainable deficits.The growth of indebtedness causes the collapse of the price stability regime after a period of rising deficits.The budget deficit is endogenously determined in the model, as a result of government's decisions on how to finance its expenditure.The alternative methods of finance are taxes, debt, and seigniorage.Under the price stability regime, only the first two methods are available, but in the long run taxes and seigniorage are the only alternatives.The price stability regime collapses when the public debt reaches an edogenously determined threshold, which makes reneging on price stability as attractive as accumulating more tax burden for the future.We are able to solve for the critical level of debt, the timing of the collapse, and the reaction of taxes to the collapse of the price stability regime. The critical level of debt depends, inter alia, on the level of government consumption, the real interest rate, the velocity of money, and the efficiency-effects of taxation.The results are illustrated by several numerical simulations.

Suggested Citation

  • Pohjola, Tapio, 2002. "Effects of fiscal policy on the durability of low inflation regimes," Bank of Finland Research Discussion Papers 14/2002, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2002_014
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/211918/1/bof-rdp2002-014.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Thomas J. Sargent & Neil Wallace, 1984. "Some Unpleasant Monetarist Arithmetic," Palgrave Macmillan Books, in: Brian Griffiths & Geoffrey E. Wood (ed.), Monetarism in the United Kingdom, pages 15-41, Palgrave Macmillan.
    2. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 345-380.
    3. Maurice Obstfeld, 1989. "Dynamic Seigniorage Theory: An Exploration," NBER Working Papers 2869, National Bureau of Economic Research, Inc.
    4. Canzoneri, Matthew B & Diba, Behzad, 1996. "Fiscal Constraints on Central Bank Independence and Price Stability," CEPR Discussion Papers 1463, C.E.P.R. Discussion Papers.
    5. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
    6. Michael Woodford, 1998. "Control of the Public Debt: A Requirement for Price Stability?," International Economic Association Series, in: Guillermo Calvo & Mervyn King (ed.), The Debt Burden and its Consequences for Monetary Policy, chapter 5, pages 117-158, Palgrave Macmillan.
    7. Rudi Dornbusch, 1998. "Debt and Monetary Policy: The Policy Issues," International Economic Association Series, in: Guillermo Calvo & Mervyn King (ed.), The Debt Burden and its Consequences for Monetary Policy, chapter 1, pages 3-27, Palgrave Macmillan.
    8. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. repec:zbw:bofrdp:2002_014 is not listed on IDEAS
    2. Pohjola, Tapio, 2002. "Effects of fiscal policy on the durability of low inflation regimes," Research Discussion Papers 14/2002, Bank of Finland.
    3. Marco Bassetto, 2002. "A Game-Theoretic View of the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 70(6), pages 2167-2195, November.
    4. Bajo-Rubio, Oscar & Díaz-Roldán, Carmen & Esteve, Vicente, 2009. "Deficit sustainability and inflation in EMU: An analysis from the Fiscal Theory of the Price Level," European Journal of Political Economy, Elsevier, vol. 25(4), pages 525-539, December.
    5. Buiter, Willem H., 1999. "The Fallacy of the Fiscal Theory of the Price Level," CEPR Discussion Papers 2205, C.E.P.R. Discussion Papers.
    6. Canzoneri, Matthew & Cumby, Robert & Diba, Behzad, 2010. "The Interaction Between Monetary and Fiscal Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 17, pages 935-999, Elsevier.
    7. Buiter, Willem H. & Sibert, Anne C., 2018. "The fallacy of the fiscal theory of the price level: One last time," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 12, pages 1-56.
    8. Łyziak, Tomasz & Mackiewicz-Łyziak, Joanna, 2020. "Does fiscal stance affect inflation expectations? Evidence for European economies," Economic Analysis and Policy, Elsevier, vol. 68(C), pages 296-310.
    9. Afonso, António & Gonçalves, Luis, 2020. "The policy mix in the US and EMU: Evidence from a SVAR analysis," The North American Journal of Economics and Finance, Elsevier, vol. 51(C).
    10. Willem Buiter, 2000. "The Fallacy of the Fiscal Theory of the Price Level, Again," CESifo Working Paper Series 303, CESifo.
    11. 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.
    12. Manuel Gonzalez-Astudillo, 2013. "Monetary-fiscal policy interactions: interdependent policy rule coefficients," Finance and Economics Discussion Series 2013-58, Board of Governors of the Federal Reserve System (U.S.).
    13. António Afonso, 2002. "Disturbing the Fiscal Theory of the Price Level: Can it Fit the EU-15," Working Papers Department of Economics 2002/01, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    14. Creel, Jerome & Bihan, Herve Le, 2006. "Using structural balance data to test the fiscal theory of the price level: Some international evidence," Journal of Macroeconomics, Elsevier, vol. 28(2), pages 338-360, June.
    15. Lin, Hsin-Yi & Chu, Hao-Pang, 2013. "Are fiscal deficits inflationary?," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 214-233.
    16. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
    17. Bajo-Rubio, Oscar & Díaz-Roldán, Carmen & Esteve, Vicente, 2014. "Deficit sustainability, and monetary versus fiscal dominance: The case of Spain, 1850–2000," Journal of Policy Modeling, Elsevier, vol. 36(5), pages 924-937.
    18. Olusola Joel Oyeleke, 2021. "On the Non-Linear Relationship between Fiscal Deficit and Inflation: The Nigeria Experience," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 27(2), pages 105-117, May.
    19. Francesco Bianchi & Leonardo Melosi, 2017. "Escaping the Great Recession," American Economic Review, American Economic Association, vol. 107(4), pages 1030-1058, April.
    20. Bianchi, Francesco & Melosi, Leonardo, 2019. "The dire effects of the lack of monetary and fiscal coordination," Journal of Monetary Economics, Elsevier, vol. 104(C), pages 1-22.
    21. Sokolova, Anna, 2015. "Fiscal limits and monetary policy: default vs. inflation," Economic Modelling, Elsevier, vol. 48(C), pages 189-198.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:bofrdp:rdp2002_014. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/bofgvfi.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.