Sustainable Fiscal Policy and Interest Rates under Flexible Exchange Rates
23 Pages Posted: 10 Dec 2010 Last revised: 20 Dec 2012
Date Written: July 1, 2008
Central to current policy debates regarding public pensions, the appropriate macroeconomic policy mix, and any number of other issues related to growth, development, poverty alleviation, and so forth, is the concept of fiscal sustainability. For neoclassical economists, fiscal sustainability is analyzed via the intertemporal government budget constraint (IGBC). Recently, the IGBC has been still more explicitly incorporated into analyses by the IMF and the World Bank internationally and in the U. S. by the Social Security/Medicare Trustees Reports and the Congressional Budget Office (whose current director, Peter Orszag, is a leading author on fiscal sustainability from within the neoclassical paradigm). The purpose of this paper is to demonstrate that key assumptions made by many applying the IGBC – most importantly the notion that interest on the national debt is set in private credit markets – in fact are not applicable to governments issuing their own currencies while operating under flexible exchange rates.
Keywords: fiscal sustainability, fiscal policy, monetary policy, central bank operations
JEL Classification: E42, E43, E61
Suggested Citation: Suggested Citation