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Fiscal Rules, Interest Payments on Debt, and the Irrelevance of the Taylor Principle
Author(s) -
Linnemann Ludger,
Schabert Andreas
Publication year - 2012
Publication title -
scottish journal of political economy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.4
H-Index - 46
eISSN - 1467-9485
pISSN - 0036-9292
DOI - 10.1111/j.1467-9485.2012.00579.x
Subject(s) - determinacy , economics , indeterminacy (philosophy) , debt , government debt , monetary economics , interest rate , fiscal policy , keynesian economics , macroeconomics , mathematical analysis , physics , mathematics , quantum mechanics
We show that in N ew K eynesian models with non‐neutral government debt, the T aylor principle ceases to be relevant for equilibrium determinacy if the government follows a fiscal rule of levying taxes in proportion to its interest payments on existing debt. This is in contrast with previous studies, which typically have assumed that taxes respond to the level of debt, and have found either a confirmation or reversal of the T aylor principle depending on the feedback from debt to taxes. We find, instead, that the equilibrium effect of the interest rate on debt is crucial for determinacy. If, as in our model, taxes are raised in response to debt interest payments, the range of indeterminacy monotonically decreases with the fiscal feedback parameter. When interest payments are completely tax‐financed, indeterminacy is ruled out without any restrictions on monetary policy.