The “mystery of the printing press” monetary policy and self-fulfilling debt crises

Giancarlo Corsetti and Luca Dedola

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We study the mechanism by which unconventional (balance-sheet) monetary policy can rule out self-fulfilling sovereign default in a model with optimizing but discretionary fiscal and monetary policymakers. By purchasing sovereign debt, the central bank e§ectively swaps risky government paper for monetary liabilities only exposed to inflation risk, thus yielding a lower interest rate. We characterize a critical threshold for central bank purchases beyond which, absent fundamental fiscal stress, the government strictly prefers primary surplus adjustment to default. Since default may still occur for fundamental reasons, however, the central bank faces the risk of losses on sovereign debt holdings, which may generate ine¢cient inflation. This risk does not undermine the credibility of a backstop, nor the ability of a central bank to pursue its inflation objectives when the latter enjoys fiscal backing or fiscal authorities are su¢ciently averse to inflation.

JEL-codes: J1 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2014-12
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://eprints.lse.ac.uk/86333/ Open access version. (application/pdf)

Related works:
Journal Article: THE MYSTERY OF THE PRINTING PRESS: MONETARY POLICY AND SELF-FULFILLING DEBT CRISES (2016)
Journal Article: The Mystery of the Printing Press: Monetary Policy and Self-Fulfilling Debt Crises (2016)
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2016)
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2014)
Working Paper: The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:86333

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