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Monetary Policy and Government Debt Dynamics Without Commitment

Dmitry Matveev

Staff Working Papers from Bank of Canada

Abstract: I show that maturity considerations affect the optimal conduct of monetary and fiscal policy during a period of government debt reduction. I consider a New Keynesian model and study a dynamic game of monetary and fiscal policy authorities without commitment, characterizing the incentives that drive the choice of interest rate. The presence of long-term bonds makes government budgets less sensitive to changes in interest rates. As a result, a reduction of government debt induced by a lack of policy commitment is associated with tight monetary policy. Furthermore, the long maturity of bonds slows down the speed of debt reduction up to the rate consistent with existing empirical evidence on the persistence of government debt. Finally, the long maturity of bonds brings down the welfare loss associated with debt reduction.

Keywords: Fiscal Policy; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E52 E62 E63 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2019-12
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:19-52

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