The Backing of Government Debt and the Price Level

Abstract

This paper studies the interdependence between fiscal and mone-tary policies, and their joint role in the determination of the price level. The fiscal authority has a long-run commitment to finance a given pro-portion, say δ, of the outstanding government debt. The remaining debt is backed by seigniorage revenue. The parameter δ characterizes the interdependence between fiscal and monetary authorities. It is shown that in a standard monetary economy, this policy rule implies that the price level depends not only on the money stock, but also on the proportion of debt that is backed with money. Empirical esti-mates of δ are obtained for OECD countries using data on nominal consumption, monetary base, and debt. Results indicate that debt plays only a minor role in the determination of the price level in these economies. Estimates of δ correlate well with institutional measures of central bank independence. ∗This paper represents work in progress and is circulated for comments only. All data and programs employed are available from the corresponding author upon request. Fi-