Like the other great European powers, France laid claim to a colonial empire in the Americas at the beginning of the eighteenth century. Yet, these territories were quickly lost, and there was little transfer of French institutions to the New World. While military failures were centrally important for this loss, France's flawed macroeconomic institutions imposed critical limits on the Crown's finances. This chapter examines the origins and operation of the French ancien régime's fiscal and monetary institutions. The weakness of these institutions contributed not only to France's difficulties in projecting its power overseas but also to the crisis and ultimately the collapse of the monarchy.

THE THEORY OF OPTIMAL MACROECONOMIC POLICY

The grand ambitions of the French Crown were held in check by its inability to conduct a more efficient macroeconomic policy that would raise the needed revenue while minimizing economic distortions. Theories of optimal macroeconomic policy and sovereign debt offer some insights into the weaknesses of French policy and what reforms were necessary.

In the simplest setting (Barro, 1987, 1989; Mankiw, 1987), optimal monetary and fiscal policy requires that the government satisfy a present value budget constraint where the outstanding current real government debt equals the sum of all present and future real tax revenues less all present and future real government expenditures. This may be restated as follows: the existing debt must be fully funded by cumulative budget surpluses.