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The maturity structure of debt, monetary policy and expectations stabilization

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  • 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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  1. Troy Davig & Eric M. Leeper, 2007. "Fluctuating Macro Policies and the Fiscal Theory," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 247-316 National Bureau of Economic Research, Inc.
  2. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
  3. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
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  1. > Macroeconomics > Monetary Theory
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Cited by:
  1. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," NBER Working Papers 16819, National Bureau of Economic Research, Inc.
  2. Francesco Bianchi & Leonardo Melosi, 2013. "Dormant Shocks and Fiscal Virtue," PIER Working Paper Archive 13-032, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  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. Eusepi, Stefano & Preston, Bruce, 2011. "Learning the fiscal theory of the price level: Some consequences of debt-management policy," Journal of the Japanese and International Economies, Elsevier, vol. 25(4), pages 358-379.
  5. 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.

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