The Sustainability of Budget Deficits in an Inflationary Economy

Harashima, Taiji (2006): The Sustainability of Budget Deficits in an Inflationary Economy.

Abstract

This paper examines fiscal sustainability in an inflationary environment, particularly the interrelation between government debt and inflation. A model that explicitly incorporates the political utility/objective function of government is constructed. The government’s borrowing behavior and inflation are determined through the simultaneous optimization of government and households. The sustainable fiscal debt in an inflationary environment was found to equal the present value of primary balances discounted by the time preference rate of government, not by the interest rate. This result raises the question of whether it is appropriate to apply the fiscal sustainability test of Hamilton and Flavin to high inflation countries.

• Item Type: MPRA Paper
• Language: English
• Keywords: Fiscal sustainability; Inflation; The present-value of primary balances; The fiscal theory of the price level; Leviathan
• Subjects: H - Public Economics > H6 - National Budget, Deficit, and Debt > H63 - Debt ; Debt Management ; Sovereign Debt; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation

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