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SEIGNIORAGE, OPERATING RULES, AND THE HIGHINFLATION TRAP*
MICHAEL BRUNO AND STANLEY FISCHER There may be both a high and a low inflation equilibrium when the government finances the deficit through seigniorage. Under rational expectations the high inflation equilibrium is stable, and the low inflation equilibrium unstable; under adaptive expectations or lagged adjustment of money balances with rational expectations, the low inflationequilibrium may be stable. Adding bond financing, dual equilibria remain if the government fixes the real interest rate, but a unique equilibrium is attained when the government sets a nominal anchor for the economy. The existence of dual equilibria is thus a result of the government's operating rules.
A given amount of seigniorage revenue can be collected at either a high or low rate ofinflation. Thus, as Sargent and Wallace [1981, 1987] and Liviatan  have shown, there may be two equilibria when a government finances its deficit by printing money. The dual equilibria-a reflection of the Laffer curve-imply that an economy may be stuck in a high inflation equilibrium when, with the same fiscal policy, it could be at a lower inflation rate.' We start by demonstrating the existence ofthe dual equilibria in a simple model in which money is the only source of deficit financing. We show that under rational expectations the high inflation equilibrium is stable and the low inflation equilibrium unstable; under adaptive expectations it may be the low inflation equilibrium that is stable.2 We than extend the model to allow for the possibility of bond financing of deficits and showthat one of the equilibria disappears if the government sets a nominal anchor for the economy, for instance, by fixing the growth rate of money. The important implication of these results is that the existence of dual equilibria, and thus the possibility of a high inflation trap, is a result of the operating rules the government chooses for monetary and fiscal policy. By ensuring that policypursues an appropriate
*We gratefully acknowledge helpful discussions with Rudi Dornbusch, comments from one of the editors and referees, and financial assistance from the National Science Foundation and the U. S.-Israel Binational Science Foundation. 1. By the same fiscal policy we mean the same budget deficit as a percentage of GNP. 2. These results are contained in an unpublished note of ours,...