Equilibrium, stability, and deficit financing in a simple nonlinear monetary model under perfect foresight

This paper shows how the nonlinearities associated with inflation taxes and interest payments give rise to problems of nonexistence and nonuniqueness of equilibria. For any choice of fiscal and monetary policy parameters, two sets of steady state equilibria are identified. One of these is associated with a nonzero rate of inflation and depends upon both the monetary and fiscal policy parameters. The other is associated with a stable price level and is independent of the monetary policy parameter. The stability properties resulting from the interaction between the sign and size of the budget deficit and alternative modes of deficit financing are analyzed. These depend critically upon the associated steady state and a variety of types of behavior may result.