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Debt, Policy Uncertainty, And Expectations Stabilization

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Listed:
  • Stefano Eusepi
  • Bruce Preston

Abstract

This paper develops a model of policy regime uncertainty and its consequences for stabilizing expectations. Because of learning dynamics, uncertainty about monetary and fiscal policy is shown to restrict, relative to a rational expectations analysis, the set of policies consistent with macroeconomic stability. Anchoring expectations by communicating about monetary and fiscal policy enlarges the set of policies consistent with stability. However, absent anchored fiscal expectations, the advantages from anchoring monetary expectations are smaller the larger is the average level of indebtedness. Finally, even when expectations are stabilized in the long run, the higher are average debt levels the more persistent will be the effects of disturbances out of rational expectations equilibrium.
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Suggested Citation

  • Stefano Eusepi & Bruce Preston, 2012. "Debt, Policy Uncertainty, And Expectations Stabilization," Journal of the European Economic Association, European Economic Association, vol. 10(4), pages 860-886, August.
  • Handle: RePEc:bla:jeurec:v:10:y:2012:i:4:p:860-886
    DOI: j.1542-4774.2012.01072.x
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    File URL: http://hdl.handle.net/10.1111/j.1542-4774.2012.01072.x
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    Citations

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    Cited by:

    1. Hollmayr, Josef & Matthes, Christian, 2015. "Learning about fiscal policy and the effects of policy uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 59(C), pages 142-162.
    2. Sinha, Arunima, 2015. "Government debt, learning and the term structure," Journal of Economic Dynamics and Control, Elsevier, vol. 53(C), pages 268-289.
    3. Stefano Eusepi & Marc Giannoni & Bruce Preston, 2012. "Long-term debt pricing and monetary policy transmission under imperfect knowledge," Staff Reports 547, Federal Reserve Bank of New York.
    4. Caprioli, Francesco, 2015. "Optimal fiscal policy under learning," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 101-124.
    5. By Anna Florio & Alessandro Gobbi, 2015. "Learning the monetary/fiscal interaction under trend inflation," Oxford Economic Papers, Oxford University Press, vol. 67(4), pages 1146-1164.
    6. Emanuel Gasteiger, 2013. "Do heterogeneous expectations constitute a challenge for policy interaction?," Working Papers Series 2 13-02, ISCTE-IUL, Business Research Unit (BRU-IUL).
    7. 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, March.
    8. Eric M. Leeper, 2010. "Monetary science, fiscal alchemy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 361-434.
    9. Bruce Preston, 2013. "Comment on "Dormant Shocks and Fiscal Virtue"," NBER Chapters,in: NBER Macroeconomics Annual 2013, Volume 28, pages 47-58 National Bureau of Economic Research, Inc.
    10. Michael Woodford, 2013. "Macroeconomic Analysis Without the Rational Expectations Hypothesis," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 303-346, May.
    11. Troy Davig & Eric M Leeper, 2011. "Temporarily Unstable Government Debt and Inflation," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 233-270, June.
    12. Richter, Alexander W., 2015. "Finite lifetimes, long-term debt and the fiscal limit," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 180-203.
    13. Jacob Engwerda & Bas van Aarle & Arie Weeren, 2015. "Debt Stabilization and Debt Mutualization in a Monetary Union with Endogenous Risk Premia," CESifo Working Paper Series 5564, CESifo Group Munich.

    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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