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Working paper

Tight Money and the Sustainability of Public Debt

In the celebrated paper “Some unpleasant monetarist arithmetic”, Sargent and Wallace (1981) showed 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, which keeps public debt on a sustainable path. High interest rates worsen the fiscal stance, but actually support the feasibility of anticipated tighter monetary policy. Thus an increase in the present discounted value of budget deficits does not necessarily have inflationary consequences.