Abstract

The combination of discretionary monetary policy, labor-market distortions, and nominal wage rigidity yields excessive inflation as monetary policy tries to exploit nominal wage contracts to address labor-market distortions. An inflation target reduces inflation, but creates a conflict between monetary policy and discretionary fiscal policy if fiscal policy is set at a higher frequency than nominal wages are. Preventing the associated excessive accumulation of public debt calls for debt ceilings. If countries differ substantially in terms of structural distortions, uniform debt ceilings must be complemented by country-specific debt targets in order to prevent decentralized fiscal authorities from employing debt policy strategically.

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Additional Information

ISSN
1538-4616
Print ISSN
0022-2879
Pages
pp. 1001-1018
Launched on MUSE
2006-01-26
Open Access
No
Archive Status
Archived 2007
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