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Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability

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Author Info
Ludger Linnemann (University of Cologne)
Andreas Schabert () (Faculty of Economics and Econometrics, University of Amsterdam)

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Abstract

We study the consequences of non-neutrality of government debt for macroeconomic stabilization policy in an environment where prices are sticky. Assuming transaction services of government bonds, Ricardian equivalence fails because public debt has a negative impact on its marginal rate of return and thus on private savings. Stability of equilibrium sequences requires a stationary evolution of real public debt, which steers inflation expectations and rules out endogenous fluctuations. Under anti-inflationary monetary policy regimes, macroeconomic fluctuations tend to decrease with the share of tax financing, which justifies tight debt constraints. In particular, a balanced budget policy stabilizes the economy under cost-push shocks, such that output and inflation variances can be lower than in a corresponding case where debt is neutral.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 05-077/2.

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Handle: RePEc:dgr:uvatin:20050077

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Keywords: Government debt fiscal and monetary policy rules stabilization policy equilibrium uniqueness

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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  1. Peter Claeys, 2007. "Estimating the effects of fiscal policy under the budget constraint," IREA Working Papers 200715, University of Barcelona, Research Institute of Applied Economics, revised Jul 2007. [Downloadable!]
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