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Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability

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  • Ludger Linnemann

    (University of Cologne)

  • Andreas Schabert

    ()
    (Faculty of Economics and Econometrics, University of Amsterdam)

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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Bibliographic Info

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

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Date of creation: 03 Aug 2005
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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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Cited by:
  1. Schabert, Andreas & van Wijnbergen, Sweder, 2006. "Debt, Deficits and Destabilizing Monetary Policy in Open Economies," CEPR Discussion Papers 5590, C.E.P.R. Discussion Papers.
  2. Claeys Peter, 2008. "Estimating the effects of fiscal policy under the budget constraint," wp.comunite 0038, Department of Communication, University of Teramo.
  3. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad & López-Salido, J David, 2008. "Monetary and Fiscal Policy Coordination when Bonds Provide Transactions Services," CEPR Discussion Papers 6814, C.E.P.R. Discussion Papers.
  4. Canzoneri, Matthew & Cumby, Robert & Diba, Behzad & López-Salido, David, 2013. "Key currency status: An exorbitant privilege and an extraordinary risk," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 371-393.

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