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Managing the inflation-output trade-off with public debt portfolios

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  • Chafwehé, Boris
  • de Beauffort, Charles
  • Oikonomou, Rigas

Abstract

When taxes do not sufficiently adjust to government debt levels, the Fiscal Theory of the Price Level predicts that inflation must adjust to ensure the solvency of public finances. We study the role of optimal debt maturity portfolios in this context, using a New Keynesian model with both demand and supply-side shocks. Our paper offers new analytical insights into the mechanisms through which the debt maturity composition affects the trade-off between inflation and the output gap: The Persistence, Discounting and Hedging channels of optimal policy. Our findings, based on a rich prior predictive analysis, indicate that the key driving force behind optimal portfolio decisions is Hedging. Moreover, the optimal maturity composition of debt is driven primarily by supply side shocks, rather than by demand shocks. Finally, our results indicate that debt management is a significant margin to complement monetary policy in stabilizing inflation when debt solvency is an important concern.

Suggested Citation

  • Chafwehé, Boris & de Beauffort, Charles & Oikonomou, Rigas, 2026. "Managing the inflation-output trade-off with public debt portfolios," Journal of Economic Dynamics and Control, Elsevier, vol. 183(C).
    • Handle: RePEc:eee:dyncon:v:183:y:2026:i:c:s0165188925002106
    DOI: 10.1016/j.jedc.2025.105244
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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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