Fiscal Rules, Interest Payments on Debt, and the Irrelevance of the Taylor Principle

16 Pages Posted: 5 Jun 2012

See all articles by Ludger Linnemann

Ludger Linnemann

University of Dortmund

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Date Written: July 2012

Abstract

We show that in New Keynesian models with non‐neutral government debt, the Taylor principle ceases to be relevant for equilibrium determinacy if the government follows a fiscal rule of levying taxes in proportion to its interest payments on existing debt. This is in contrast with previous studies, which typically have assumed that taxes respond to the level of debt, and have found either a confirmation or reversal of the Taylor principle depending on the feedback from debt to taxes. We find, instead, that the equilibrium effect of the interest rate on debt is crucial for determinacy. If, as in our model, taxes are raised in response to debt interest payments, the range of indeterminacy monotonically decreases with the fiscal feedback parameter. When interest payments are completely tax‐financed, indeterminacy is ruled out without any restrictions on monetary policy.

Suggested Citation

Linnemann, Ludger and Schabert, Andreas, Fiscal Rules, Interest Payments on Debt, and the Irrelevance of the Taylor Principle (July 2012). Scottish Journal of Political Economy, Vol. 59, Issue 3, pp. 250-265, 2012. Available at SSRN: https://ssrn.com/abstract=2077369 or http://dx.doi.org/10.1111/j.1467-9485.2012.00579.x

Ludger Linnemann

University of Dortmund ( email )

Department of Economics
Dortmund, D-44221
Germany

Andreas Schabert

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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