The paper considers the role of limits upon the permissible growth of public debt, like those
stipulated in the Maastricht treaty, in making price stability possible, It is shown that a certain type
of fiscal instability, namely variations in the present value of current and future primary government
budgets, necessarily results in price level instability, in the sense that there exists no possible
monetary policy that results in an equilibrium with stable prices. In the presence of sluggish price
adjustment, the fiscal shocks disturb real output and real interest rates as well.
On the other hand, shocks of this kind can be eliminated by a Maastricht-type limit on the
value of the public debt. In the presence of the debt limit (and under assumptions of frictionless
financial markets, etc.), “Ricardian equivalence” holds, and fiscal shocks have no effects upon real
or nominal variables. Furthermore, an appropriate monetary policy rule can ensure price stability
even in the face of other kinds of real shocks. Thus the debt limit serves as a precondition for the
common central bank in a monetary union to be charged with responsibility for maintaining a stable
value for the common currency.
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