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Debt monetization, inflation, and the ‘neutral’ interest rate


  • Alfonso Palacio-Vera


The main purpose of this study is to explore the potential expansionary effect stemming from the monetization of debt. We develop a simple macroeconomic model with Keynesian features and four sectors: creditor and debtor households, businesses, and the public sector. We show that such expansionary effect stems mainly from the reduction in the financial cost to servicing the public debt. The efficacy of the channel that operates allegedly through the compression of the risk/term premium on securities is found to be ambiguous. Finally, we show that countries that issue their own currency can avert getting stuck in a structural ‘liquidity trap’ provided their central banks are willing to monetize the debt created by a strong enough fiscal expansion.

Suggested Citation

  • Alfonso Palacio-Vera, 2012. "Debt monetization, inflation, and the ‘neutral’ interest rate," International Review of Applied Economics, Taylor & Francis Journals, vol. 26(2), pages 267-285, September.
  • Handle: RePEc:taf:irapec:v:26:y:2012:i:2:p:267-285
    DOI: 10.1080/02692171.2011.624497

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    References listed on IDEAS

    1. Engelbert Stockhammer & Eckhard Hein & Lucas Grafl, 2011. "Globalization and the effects of changes in functional income distribution on aggregate demand in Germany," International Review of Applied Economics, Taylor & Francis Journals, vol. 25(1), pages 1-23.
    2. Taylor, Lance, 1985. "A Stagnationist Model of Economic Growth," Cambridge Journal of Economics, Oxford University Press, vol. 9(4), pages 383-403, December.
    3. Arestis, Philip & McCauley, Kevin & Sawyer, Malcolm, 2001. "An Alternative Stability Pact for the European Union," Cambridge Journal of Economics, Oxford University Press, vol. 25(1), pages 113-130, January.
    4. Engelbert Stockhammer & Özlem Onaran & Stefan Ederer, 2009. "Functional income distribution and aggregate demand in the Euro area," Cambridge Journal of Economics, Oxford University Press, vol. 33(1), pages 139-159, January.
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