Political Shocks, Public Debt and the Design of Monetary and Fiscal Institutions
AbstractWe explore the dynamics of public debt in the presence of political shocks, in the form of shocks to preferences for public spending. Under commitment, optimal stabilization is obtained by combining an inflation target that is contingent on the political shock with a debt target that forces the government to fully absorb the political shock in the period in which it occurs. With only a shock-contingent inflation target, the political shock is spread out over time through debt policy. In the absence of any targets, a conservative central bank can enhance stabilization. If we extend the basic two-period model to an infinite horizon, this result is preserved. Moreover, under rather general circumstances the government tends to decumulate debt over time, so that in the long run all targets (for inflation, output and public spending) are attained. A failure to commit monetary policy introduces an additional distortion into the model, which leads the government to decumulate debt at a faster rate.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3753.
Date of creation: Feb 2003
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Find related papers by JEL classification:
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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- Ali al-Nowaihi & Paul Levine & Alex Mandilaras, 2006. "Central Bank Independence and the `Free Lunch Puzzle': A New Perspective," School of Economics Discussion Papers 0806, School of Economics, University of Surrey.
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