Volume 3, Issue 2 June 2007

Low Nominal Interest Rates: A Public Finance Perspective

Abstract

This paper studies low-interest-rate policies from a public finance perspective. Two policy regimes are considered. In the first regime, the central bank is subordinate and its budget is integrated into the fiscal authority's budget constraint. In this case, monetary policy influences the revenue mainly through currency seigniorage. In the other regime, the central bank's budget is separated from that of the fiscal authority. Commitment to a low nominal interest rate forces the central bank to inject money when the primary deficit increases. Thus, even if the budgets are separated, the central bank's actions are constrained by the fiscal authority. Under a "passive" Taylor rule, a reduction in the nominal interest rate lowers the government revenue.