The fiscal policy environment central banks operate in can be radically different with
respect to debt levels, maturity structures and whether or not fiscal adjustments are spendingor
tax-based. Despite this, most analyses of monetary policy delegation schemes typically
ignore the behavior of the fiscal policy maker. This paper investigates whether delegating
either nominal income or price level targets to a monetary authority yields social gains in
an economy with government debt, where the fiscal policymaker, acting strategically, may
support or undermine the policies of the central bank. We argue that the fiscal environment
plays an important role in determining the performance of monetary policy. The gains to
price level targeting typically found in the literature can be overturned at empirically relevant
debt-to-GDP ratios, when debt stabilization is achieved through spending cuts. In contrast
these gains are retained if the fiscal authorities utilize taxes to respond to shocks and stabilize
debt.