NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Fiscal Limits and Monetary Policy

Eric M. Leeper

NBER Working Paper No. 18877
Issued in March 2013
NBER Program(s):   EFG

Every economy faces a "fiscal limit" that delivers the maximum government debt-GDP ratio that can be sustained without appreciable risk of default or higher inflation. But governments in advanced economies issue substantial nominal debt and nominal debt is a commitment to repay in nominal units. When such economies are approaching their fiscal limits, debt can be devalued through higher current and future inflation rates. The paper develops a simple bond market supply-demand apparatus to explain how fiscal policy can be a source of inflation, while monetary policy merely determines the timing of inflation.

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Acknowledgments

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Published: Eric M. Leeper, 2013. "Fiscal Limits and Monetary Policy," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 13(2), pages 33-58.

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