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Deteriorating Public Finances and Rising Government Debt: Implications for Monetary Policy

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Author Info

  • Lillian Cheung

    (Research Department, Hong Kong Monetary Authority)

  • Chi-Sang Tam

    (Research Department, Hong Kong Monetary Authority)

  • Jessica Szeto

    (Research Department, Hong Kong Monetary Authority)

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    Abstract

    The sharp rise in government debt in many major economies following the introduction of large fiscal stimulus measures during the global financial crisis of 2008-09 has triggered concerns over its impact on long-term interest rates and the potential negative consequences for future growth and inflation. This paper uses an error-correction model to assess the effect of growing government debt on long-term real interest rates by drawing on empirical evidence from the US. The results show that in the long run, a one-percentage-point increase in the federal debt-to-GDP ratio raises the equilibrium 10-year real US Treasury yield by about six basis points. We also discuss the economic consequences of a rise in the world long-term interest rates, and draw implications for longer-term growth and the conduct of monetary policy in the Asian economies.

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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP09_15_full.pdf
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    Bibliographic Info

    Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0915.

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    Length: 18 pages
    Date of creation: Aug 2009
    Date of revision:
    Handle: RePEc:hkg:wpaper:0915

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    Related research

    Keywords: Public debt; fiscal policy; monetary policy; long term interest rate; real interest rate; error-correction model;

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    References

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    1. Anne-Marie Brook, 2003. "Recent and Prospective Trends in Real Long-Term Interest Rates: Fiscal Policy and other Drivers," OECD Economics Department Working Papers, OECD Publishing 367, OECD Publishing.
    2. Joseph E. Gagnon, 1996. "Net foreign assets and equilibrium exchange rates: panel evidence," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 574, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:
    1. Zhang, Zhiwei & Zhang, Wenlang, 2011. "The road to recovery: Fiscal stimulus, financial sector rehabilitation, and potential risks ahead," Journal of Asian Economics, Elsevier, Elsevier, vol. 22(4), pages 311-321, August.

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