Tight Money and the Sustainability of Public Debt
In the celebrated paper “Some unpleasant monetarist arithmetic”, Sargent and Wallace (1981) show that tight monetary policy is not feasible unless it is supported by appropriate fiscal adjustment. In this paper, we explore a simple forward-looking monetary model to show that an anticipated decrease in the growth rate of base money is not necessarily characterized by “unpleasant arithmetic”. This is due to a possible transitory gain in seigniorage supported by a temporal decrease in the real interest rate, which keeps public debt on a sustainable path. An important implication is that an increase in the present value of future budget deficits does not necessarily have inflationary consequences.