Comment on T. J. Sargent and N. Wallace

Sargent and Wallace (S-W) show that, even when inflation is prima facie a strictly monetary phenomenon -- prices are flexible, markets clear and velocity is constant --^inflation is, in the long run, a fiscal phenomenon. This follows from the government budget constraint and the existence of an upper bound on the real per capita stock of interest bearing public debt held by the private sector. Together these ensure that in the long run the growth of the money stock is governed by the fiscal deficit, if we assign to the fiscal authorities the role of Stackelberg leaders and to the monetary authorities that of Stackelberg followers. The discussion of the formal S-W model focuses on the distinct roles of public spending and explicit taxes in their model and on the possibility that optimal policy involves public sector surpluses and a net credit position of the public sector vis-a-vis the private sector. It is also argued that the specification of the demand for and supply of - money is ad hoc, a weakness shared by most existing macro models.. Finally it is shown that if we adjust the published government deficit figures for the effect of inflation on the^real value of the stock of nom