Optimal Fiscal and Monetary Policy with Distorting Taxes

When the interest rate on government debt is low enough, it becomes possible to roll it over indefinitely, never taxing to retire it, without producing a growing debt to GDP ratio. This has been called a situation with zero “fiscal cost†to debt.But when low interest on debt arises from its providing liquidity services, zero fiscal cost is equivalent to finance through seigniorage. Some finance through seigniorage is generally optimal, however, despite results in the literature seeming to show that this is not so.