Central Bank Independence, Government Debt and the Re-Normalization of Interest Rates

Tatiana Kirsanova, Campbell Leith and Ding Liu

Working Papers from Business School - Economics, University of Glasgow

Abstract: We develop a New Keynesian model augmented with a rich description of fiscal policy, including debt maturity structure, where two policymakers- an independent inflation-averse central bank and a (potentially) populist fiscal authority- interact strategically. Central bank independence initially improves inflation outcomes, but this results in reduced fiscal discipline and increased debt. Eventually this leads to inflation lying above pre-independence levels. Introducing a ‘flight-to-safety’ regime, which suppresses the interest rates households require to hold government debt, and a conventional regime, where their time preferences return to normal, allows us to explore how changes in the natural rate can dramatically affect debt dynamics and inflation outcomes. The model offers an explanation of the buildup of government debt since the financial crisis and the subsequent emergence of significant inflation

Keywords: New Keynesian Model; Central Bank Independence; Government Debt; Monetary Policy; Fiscal Policy; Time Consistency. (search for similar items in EconPapers)
JEL-codes: E31 E43 E62 E63 (search for similar items in EconPapers)
Date: 2024-10
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:gla:glaewp:2024_10

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