Central Bank Instruments, Fiscal Policy Regimes, and the Requirements for Equilibrium Determinacy
Tinbergen Institute Discussion Paper No. 2006-025/2
30 Pages Posted: 28 Mar 2006
Date Written: February 28, 2006
This paper examines the role of the monetary instrument choice for local equilibrium determinacy under sticky prices and different fiscal policy regimes. Corresponding to Benhabib et al.'s (2001) results for interest rate feedback rules, the money growth rate should not rise by more than one for one with inflation when the primary surplus is raised with public debt. Under an exogenous primary surplus, money supply should be accommodating - such that real balances grow with inflation - to ensure local equilibrium determinacy. When the central bank links the supply of money to government bonds by controlling the bond-to-money ratio, an inflation stabilizing policy can be implemented for both fiscal policy regimes. Local determinacy is then ensured when the bond-to-money ratio is not extremely sensitive to inflation, or when interest payments on public debt are entirely tax financed, i.e., the budget is balanced.
Keywords: Fiscal-Monetary Policy Interaction, Money Growth, Bond-to-Money Ratio
JEL Classification: E52, E63, E32
Suggested Citation: Suggested Citation