DEBT NONNEUTRALITY, POLICY INTERACTIONS, AND MACROECONOMIC STABILITY

Ludger Linnemann and Andreas Schabert

International Economic Review, 2010, vol. 51, issue 2, 461-474

Abstract: We study the consequences of nonneutrality of government debt for macroeconomic stabilization policy in a sticky-price model. Ricardian equivalence fails because debt has a negative impact on its rate of return and on private savings, which is induced by assuming transaction services of bonds. Under aggressive monetary policy regimes, macroeconomic fluctuations tend to be stabilized if nominal budget deficits are low. A smooth debt path limits inflation expectations, such that inflation variances can be reduced. Under a balanced budget policy, the central bank's output gap-inflation volatility trade-off is improved relative to an environment where debt is neutral. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 2010
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Related works:
Working Paper: Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability (2005)
Working Paper: Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability (2004)
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