A Fiscal Theory of Money and Banking

48 Pages Posted: 2 Jul 2021

See all articles by Ping He

Ping He

Tsinghua University, SEM

Zehao Liu

School of Finance, Renmin University of China

Chengbo Xie

School of Finance, SWUFE

Multiple version iconThere are 3 versions of this paper

Date Written: June 27, 2021

Abstract

We introduce banks to the fiscal theory of price level to study the effectiveness of open market operations in correcting the distortions caused by an improper tax rate. A rise in the tax rate increases the real purchasing power of payment liquidity for short-term consumption, but reduces firms' incentive to take loans for long-term investment. An excessively low tax rate leads to an over-investment problem, which can be rectified by a combination of reverse repo operations and a positive reserve requirement. The optimal reverse repo rate is a function of the “fiscal gap”, that is, the difference between the optimal tax rate and the actual tax rate. By contrast, an excessively high tax rate leads to an under-investment problem. Open market operations are ineffective in this case as the zero lower bound of interest rates prevents the central bank from injecting additional credit to the economy.

Keywords: Liquidity Shocks; Fiscal Policy; Monetary Policy; Fiscal Theory of Price Level; Monetization of Fiscal Debt

JEL Classification: E52; E62; E63; G21; G28

Suggested Citation

He, Ping and Liu, Zehao and Xie, Chengbo, A Fiscal Theory of Money and Banking (June 27, 2021). Available at SSRN: https://ssrn.com/abstract=3874760 or http://dx.doi.org/10.2139/ssrn.3874760

Ping He

Tsinghua University, SEM ( email )

Beijing, 100084
China
8610-62795754 (Phone)
8610-62784554 (Fax)

HOME PAGE: http://www.sem.tsinghua.edu.cn/en/heping

Zehao Liu (Contact Author)

School of Finance, Renmin University of China ( email )

Ming De Main Building
Renmin University of China
Beijing, Beijing 100872
China

Chengbo Xie

School of Finance, SWUFE ( email )

Gezhi Building, SWUFE
518
Chengdu, Sichuan
China

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