Default Risk on Government Bonds, Deflation, and Inflation
AbstractThis paper analyzes the impact of deflation and inflation on the real interest rates of GBs using an overlapping generations model with the relationship between the real interest rate of GBs and the fiscal consolidation rule. We find that deflation may lower the real interest rate of GBs to the same level of public debt to capital, even if the fiscal consolidation rule is the same, as opposed to the conventional view that the real interest rate of GBs is determined independent of deflation if the Fisher equation holds. Our results are consistent with how the real interest rates of Japanese GBs react in periods of deflation. This paper also addresses the impact of fiscal inflation (i.e., monetizing all parts of the GB’s default using monetary policy). We calculate the expected fiscal inflation when the default rate in the event of fiscal consolidation is raised. The fiscal inflation may be extremely high if the extent of the required tax increase in fiscal consolidation is low. Initial inflation accelerates the expected fiscal inflation, but initial deflation suppresses it.
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Bibliographic InfoPaper provided by Center for Intergenerational Studies, Institute of Economic Research, Hitotsubashi University in its series CIS Discussion paper series with number 537.
Length: 27 p.
Date of creation: Feb 2012
Date of revision:
Overlapping generations model; real interest rate; fiscal consolidation rule; default risk; fiscal inflation;
Find related papers by JEL classification:
- E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
- H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
- H5 - Public Economics - - National Government Expenditures and Related Policies
- H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-02-27 (All new papers)
- NEP-CBA-2012-02-27 (Central Banking)
- NEP-DGE-2012-02-27 (Dynamic General Equilibrium)
- NEP-MAC-2012-02-27 (Macroeconomics)
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