Distortionary Taxation, Debt, and the Price Level

Andreas Schabert and L. v. Thadden
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L. v. Thadden: European Central Bank

No 75, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: This paper considers the nominal and real determinacy of equilibria under an exogenously specified path of interest rates in an economy in which taxation is either lump-sum or distortionary. Under lump-sum taxation, we confirm the well-known finding that equilibria display nominal (in)determinacy if the primary surplus is exogenous (endogenous). Under distortionary taxation, this classification is no longer relevant. Nominal determinacy is always ensured since distortionary taxes establish a link between the allocation and the sequences of taxes and debt and, hence, the price level, regardless of whether the primary surplus is exogenous or endogenous. Distortionary taxation, however, increases the scope for real indeterminacy. As a general feature, the real (in)determinacy of equilibria depends on the interaction of fiscal and monetary policies, i.e. on the sequences of taxes, debt, and interest rates. If, for example, fiscal policy runs a balanced budget the central bank should set the nominal interest rate in a way consistent with long-run deflation in order to ensure real determinacy. This finding is different from a balanced-budget policy under lump-sum taxes where no such qualification with respect to the interest rate needs to be made

Keywords: Monetary and fiscal policy; Distortionary taxes; Price level determination; Balanced budget policy (search for similar items in EconPapers)
JEL-codes: E31 E63 (search for similar items in EconPapers)
Date: 2006-07-04
New Economics Papers: this item is included in nep-cba, nep-mac and nep-pbe
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Distortionary Taxation, Debt, and the Price Level (2009)
Working Paper: Distortionary taxation, debt, and the price level (2006)
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