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Alternative Perspectives on Optimal Public Debt Adjustment

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  • Michal Horvath

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Abstract

We compare alternative optimal public debt adjustment strategies in a New Keynesian economy. We find that the unconditionally optimal policy is consistent with a gradual adjustment in public debt towards its mean value at a speed determined by the rate of time preference of agents. To a second-order approximation in a stochastic setting, debt follows a unit root process with a negative drift under the 'timeless-perspective' approach but converges to an unconditional mean different from the non-stochastic steady state in the unconditionally optimal economy. Overall, increases in public debt are shown to be optimally reduced by half only after approximately two decades at best.

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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200607.

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Date of creation: 15 Jun 2006
Date of revision: 15 Sep 2011
Handle: RePEc:san:cdmawp:0607

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Keywords: Optimal Monetary and Fiscal Policy; Unconditionally Optimal Policy; Timeless Perspective; Public Debt Dynamics; Second-Order Approximation.;

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  13. Christian Jensen & Bennett C. McCallum, 2002. "The Non-Optimality of Proposed Monetary Policy Rules Under Timeless-Perspective Commitment," NBER Working Papers 8882, National Bureau of Economic Research, Inc.
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