The Conduct of Monetary Policy with a Shrinking Stock of Government Debt

Stacey Schreft and Bruce Smith

Journal of Money, Credit and Banking, 2002, vol. 34, issue 3, 848-82

Abstract: This article considers the consequences for a central bank of a declining stock of government debt. The model has a treasury that taxes, spends, and issues debt; a central bank that conducts open market operations in treasury debt; and banks that intermediate private savings. It suggests that a sufficiently small stock of debt can put an economy on the Pareto inferior side of the seigniorage Laffer curve, implying unnecessarily high inflation. If there is also a primary budget deficit, equilibrium might not exist. Discount-window lending is a potentially desirable alternative to open market operations, especially if the loans are not subsidized.

Date: 2002
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