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Idiosyncratic Risk, Government Debt and Inflation

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  • Matthias Hansel

Abstract

How does public debt matter for price stability? If it is useful for the private sector to insure idiosyncratic risk, even transitory government debt expansions can exert upward pressure on interest rates and create inflation. As I demonstrate using an analytically tractable model, this holds in the presence of an active Taylor rule and does not require the absence of future fiscal consolidation. Further analysis using a quantitative 2-asset HANK model reveals the magnitude of the mechanism to crucially depend on the structure of the asset market: under common assumptions, the interest rate effects of public debt are either overly strong or overly weak. After disciplining this aspect based on evidence regarding its long-term relationship with treasury returns, my framework indicates relevant short-run effects of public debt on inflation under active monetary policy: In particular, in the HANK model the mechanism can account for US inflation remaining elevated in 2023 and afterwards.

Suggested Citation

  • Matthias Hansel, 2024. "Idiosyncratic Risk, Government Debt and Inflation," Papers 2403.00471, arXiv.org, revised Nov 2024.
    • Handle: RePEc:arx:papers:2403.00471
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    References listed on IDEAS

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    1. Mary Amiti & Sebastian Heise & Fatih Karahan & Ayşegül Şahin, 2024. "Inflation Strikes Back: The Role of Import Competition and the Labor Market," NBER Macroeconomics Annual, University of Chicago Press, vol. 38(1), pages 71-131.
    2. Ascari, Guido & Rankin, Neil, 2013. "The effectiveness of government debt for demand management: Sensitivity to monetary policy rules," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1544-1566.
    3. Francesco Bianchi & Renato Faccini & Leonardo Melosi, 2023. "A Fiscal Theory of Persistent Inflation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 138(4), pages 2127-2179.
    4. Eric M. Engen & R. Glenn Hubbard, 2005. "Federal Government Debt and Interest Rates," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 83-160, National Bureau of Economic Research, Inc.
    5. Christian Bayer & Ralph Luetticke & Lien Pham‐Dao & Volker Tjaden, 2019. "Precautionary Savings, Illiquid Assets, and the Aggregate Consequences of Shocks to Household Income Risk," Econometrica, Econometric Society, vol. 87(1), pages 255-290, January.
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    Cited by:

    1. Galo Nuño, 2025. "Three Theories of Natural Rate Dynamics," Working Papers 2528, Banco de España.

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    More about this item

    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
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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