We study the nature of the optimal monetary policy in a regime of “fiscal dominance” when the monetary authority -that can print money or issue interest earning debt- is required to finance an exogenous sequence of transfers to the Treasury. We show that the degree of commitment on the part of the monetary authority has a significant impact on the details of the optimal policy. We apply this model to the recent experience of Argentina and we find that the inflation rate experienced by Argentina during the first year of the monetary program is close to the predictions of the weakly time consistent solution. Moreover, consistent with both versions of the model, the Argentine central bank has increased the ratio of interest earning debt to monetary base.

The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.