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Monetary Commitment and the Level of Public Debt

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  • Stefano Gnocchi
  • Luisa Lambertini

Abstract

We analyze the interaction between committed monetary policy and discretionary fiscal policy in a model with public debt, endogenous government expenditures, distortive taxation and nominal rigidities. Fiscal decisions lack commitment but are Markov-perfect. Monetary commitment to an interest rate path leads to a unique level of debt. This level of debt is positive if the central bank adopts closed-loop strategies that raise the real interest rate when inflation is above target owing to fiscal deviations. More aggressive defence of the inflation target implies lower debt and higher welfare. Simple Taylor-type interest rate rules achieve welfare levels similar to those generated by sophisticated closed-loop strategies.

Suggested Citation

  • Stefano Gnocchi & Luisa Lambertini, 2016. "Monetary Commitment and the Level of Public Debt," Staff Working Papers 16-3, Bank of Canada.
    • Handle: RePEc:bca:bocawp:16-3
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    References listed on IDEAS

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    2. Stephen S. Poloz, 2016. "The Doug Purvis Memorial Lecture—Monetary/Fiscal Policy Mix and Financial Stability: The Medium Term Is Still the Message," Discussion Papers 16-13, Bank of Canada.

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    More about this item

    Keywords

    Credibility; Fiscal policy; Inflation targets; Monetary policy framework;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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