about defining monetary policy as distinct from fiscal policy. An open market purchaseincreases the stock of money, but by reducing theinterest-bearing governmentdebt held by the public, it has implications for the future stream of taxes needed tofinance the interest cost of the government’s debt. So an open market operationpotentially hasa fiscal side to it, and this fact can lead to ambiguity in defining what
one means by a change in monetary policy, holding fiscal policy constant.
The literature in monetary economics has analyzedseveral alternative assumptionsabout the relationship between monetary and fiscal policies. In most traditionalanalyses, fiscal policy is assumed to adjust to ensure that the government’sintertemporalbudget is always in balance, while monetary policy is free to set the nominal
money stock or the nominal rate of interest. This situation is described as aRicardian regime (Sargent 1982), one ofmonetary dominance, or one in which fiscalpolicy is passive and monetary policy is active (Leeper 1991). In a regime of monetary dominance, the monetary
authority can determine inflation andseigniorage, in which case the fiscal authority must adjust either taxes or spending to ensure that (4.13) is satisfied
4.3.1 Fiscal Dominance, Deficits, and Inflation
The intertemporal budget constraintimplies that any government with a current outstanding debt must run, in present value terms, future surpluses.
This interpretation views fiscal policy as set independently, so that
the monetaryauthority is forced to generate enough seigniorage to satisfy the intertemporal
budget balance condition. Leeper (1991) describes such a situation as one
in which there is an active fiscal policy anda passive monetary policy. It is also
described as a situation of fiscal dominance.
Given the real value of the government’s liabilities bt_1, (4.13) illustrates what
Sargent and Wallace...