Debt Stabilisation Bias and the Taylor Principle: Optimal Policy in a New Keynesian Model with Government Debt and Inflation Pe

David Vines and Sven Jari Stehn ()

No 6696, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Leith and Wren-Lewis (2007) have shown that government debt is returned to its pre-shock level in a New Keynesian model under optimal discretionary policy. This has two important implications for monetary and fiscal policy. First, in a high-debt economy, it may be optimal for discretionary monetary policy to cut the interest rate in response to a cost-push shock - thereby violating the Taylor principle - although this will not be true if inflation is significantly persistent. Second, the optimal fiscal response to such a shock is more active under discretion than commitment, whatever the degree of inflation persistence.

Keywords: Government debt; Monetary policy; Stabilisation bias; Fiscal policy (search for similar items in EconPapers)
JEL-codes: E52 E60 E61 E63 (search for similar items in EconPapers)
Date: 2008-02
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (7)

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