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Debt Nonneutrality, Policy Interactions, And Macroeconomic Stability

  • Ludger Linnemann
  • Andreas Schabert

We study the consequences of nonneutrality of government debt for macroeconomic stabilization policy in a sticky-price model. Ricardian equivalence fails because debt has a negative impact on its rate of return and on private savings, which is induced by assuming transaction services of bonds. Under aggressive monetary policy regimes, macroeconomic fluctuations tend to be stabilized if nominal budget deficits are low. A smooth debt path limits inflation expectations, such that inflation variances can be reduced. Under a balanced budget policy, the central bank's output gap-inflation volatility trade-off is improved relative to an environment where debt is neutral. Copyright (2010) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 51 (2010)
Issue (Month): 2 (05)
Pages: 461-474

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Handle: RePEc:ier:iecrev:v:51:y:2010:i:2:p:461-474
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