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Dynamic fiscal limits and monetary-fiscal policy interactions

Niccolò Battistini (), Giovanni Callegari and Luca Zavalloni

No 2268, Working Paper Series from European Central Bank

Abstract: This paper analyzes the impact of monetary policy on public debt sustainability through the lens of a general equilibrium model with fiscal limits. We find that the mere possibility of a binding ZLB may have detrimental effects on debt sustainability, as a kink in the Laffer curve induces a dead-weight loss in the present discounted value of future primary surpluses. Moreover, debt sustainability improves with monetary policy activeness, that is, with the elasticity of the interest rate to changes in inflation and the output gap. On this basis, we assess the trade-off between economic stabilization and debt sustainability depending on the monetary policy environment. In normal times, large public spending shocks may engender perverse debt dynamics and cause economic contractions. At the ZLB, a muted trade-off between stabilization and sustainability instead expands the fiscal margin, especially if coupled with a commitment to a more active monetary policy during normal times. JEL Classification: E52, E61, E63

Keywords: fiscal sustainability; monetary policy; ZLB (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
Date: 2019-04
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20192268

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