Working Paper

Monetary Policy and Liquid Government Debt

Abstract: We examine the conduct of monetary policy in a world where the supply of outside money is controlled by the fiscal authority-a scenario increasingly relevant for many developed economies today. Central bank control over the long-run inflation rate depends on whether fiscal policy is Ricardian or Non-Ricardian. The optimal monetary policy follows a generalized Friedman rule that eliminates the liquidity premium on scarce treasury debt. We derive conditions for determinacy under both fiscal regimes and show that they do not necessarily correspond to the Taylor principle. In addition, Non-Ricardian regimes may suffer from multiplicity of steady-states when the government runs persistent deficits.

Keywords: monetary policy; inflation; Taylor rule; determinacy; Ricardian; liquid bonds;

JEL Classification: E40; E52; E60; E63;

https://doi.org/10.20955/wp.2018.002

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2018-01-16

Number: 2018-2

Pages: 37 pages