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The maturity structure of debt, monetary policy and expectations stabilization

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Author Info

  • Bruce Preston

    (Columbia University and NBER)

  • Stefano Eusepi

    (Federal Reserve bank of New York)

Abstract

This paper identifies a channel by which changes in the size and composition of government debt might generate macroeconomic instability in a standard New Keynesian model. The mechanism depends on failures of Ricardian equivalence because of learning dynamics. Under rational expectations, the model has the prediction that Ricardian equivalence holds, and the scale and composition of public debt held by households is irrelevant to the determination of inflation and output. Under learning, holdings of the public debt are perceived as net wealth, with the resulting expenditure effects shown to be destabilizing, depending on both the scale and composition of the public debt. Very short and long average debt maturities are conducive to stability, while short-to-medium average maturities tend to generate instability in the sense that much more aggressive monetary policy is required to prevent divergent learning dynamics. More heavily indebted economies are more sensitive to adjustments in maturity structure. This suggests there might be considerations, aside from the presumed stimulus from large-scale asset purchases via lower longer-term interest rates, that are relevant to evaluating recent proposals for further quantitative easing in the United States.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1287.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1287

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Fax: 1-860-486-4463
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. > Macroeconomics > Monetary Theory
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Cited by:
  1. Eusepi, Stefano & Giannoni, Marc & Preston, Bruce, 2012. "Long-Term Debt Pricing and Monetary Policy Transmission under Imperfect Knowledge," CEPR Discussion Papers 8845, C.E.P.R. Discussion Papers.
  2. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," Economic Papers, The Economic Society of Australia, vol. 30(1), pages 33-47, 03.
  3. Vasco Curdia & Andrea Ferrero & Han Chen, 2012. "The Macroeconomic Effects of Large-Scale Asset Purchase Programs," 2012 Meeting Papers 372, Society for Economic Dynamics.
  4. Stefano Eusepi & Bruce Preston, 2011. "Learning the fiscal theory of the price level: some consequences of debt management policy," Staff Reports 515, Federal Reserve Bank of New York.
  5. Leonardo Melosi & Francesco Bianchi, 2012. "Dormant Shocks and Fiscal Virtue," 2012 Meeting Papers 44, Society for Economic Dynamics.

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