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Debt Management in a World of Fiscal Dominance

Boris Chafwehé (), Charles de Beauffort () and Rigas Oikonomou

No 2021-11, JRC Working Papers on Taxation & Structural Reforms from Joint Research Centre (Seville site)

Abstract: We study the impact of debt maturity management in an economy where monetary policy is 'passive' and subservient to fiscal policy. We setup a tractable model, to characterize analytically the dynamics of inflation, as well as other macroeconomic variables, showing their dependence on the monetary policy rule and on the maturity of debt. Debt maturity becomes a key variable when the monetary authority reacts to inflation and the appropriate maturity of debt can restore the efficacy of monetary policy in controlling inflation. This requires debt management to focus on issuing long bonds. Moreover, we propose a novel framework of Ramsey optimal coordinated debt and monetary policies, to derive analytically the interest rate rule followed by the monetary authority as a function of debt maturity. The optimal policy model leads to the same prescription, long-term debt financing enables to stabilize inflation. Lastly, the relevance of debt maturity in reducing inflation variability is also confirmed in a medium scale DSGE model estimated with US data.

Keywords: Passive Monetary Policy; Government Debt Management; Fiscal and Monetary Policy Interactions; Bayesian estimation; Ramsey policy. (search for similar items in EconPapers)
JEL-codes: C11 E31 E52 E58 E62 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2021-07
New Economics Papers: this item is included in nep-cba, nep-cwa and nep-mac
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