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The Impact of Debt Levels and Debt Maturity on Inflation

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  • Faraglia, Elisa
  • Marcet, Albert
  • Oikonomou, Rigas
  • Scott, Andrew

Abstract

In the context of a sticky price DSGE model subject to government expenditure and preference shocks where governments issue only nominal non-contingent bonds we examine the implications for optimal inflation of changes in the level and average maturity of government debt. We analyse these relationships under two different institutional settings. In one case government pursues optimal monetary and fiscal policy in a coordinated way whereas in the alternative we assume an independent monetary authority that sets interest rates according to a Taylor rule and where the fiscal authority treats bond prices as a given. We identify the main mechanisms through which inflation is affected by debt and debt maturity (a real balance effect and an implicit profit tax) and also study additional channels through which the government achieves fiscal sustainability (tax smoothing, interest rate twisting and endogenous fluctuations in bond prices). In the case of optimal coordinated monetary and fiscal policy we find that the persistence and volatility of inflation depends on the sign, size and maturity structure of government debt. High levels of government debt do lead to higher inflation and longer maturity debt leads to more persistent inflation. However even in the presence of modest price stickiness the role of inflation is minor with the majority of fiscal adjustment achieved through changes in taxes and the primary surplus. However in the case of an independent monetary authority where debt management, monetary policy and fiscal policy are not coordinated then inflation has a much more substantial and more persistent role to play. Inflation is higher, more volatile and more persistent especially in response to preference shocks and plays a major role in achieving fiscal solvency.

Suggested Citation

  • Faraglia, Elisa & Marcet, Albert & Oikonomou, Rigas & Scott, Andrew, 2012. "The Impact of Debt Levels and Debt Maturity on Inflation," CEPR Discussion Papers 9257, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:9257
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    References listed on IDEAS

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    Cited by:

    1. repec:exl:25engi:v:27:y:2016:i:2:p:134-143 is not listed on IDEAS
    2. Eric M Leeper & Campbell Leith & Ding Liu, 2016. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Working Papers 2016_04, Business School - Economics, University of Glasgow.
    3. Galo Nuño & Carlos Thomas, 2015. "Monetary policy and sovereign debt vulnerability," Working Papers 1517, Banco de España;Working Papers Homepage.
    4. Galstyan, Vahagn & Velic, Adnan, 2017. "Debt thresholds and real exchange rates: An emerging markets perspective," Journal of International Money and Finance, Elsevier, vol. 70(C), pages 452-470.
    5. Howard Kung & Gonzalo Morales & Alexandre Corhay, 2017. "Fiscal Discount Rates and Debt Maturity," 2017 Meeting Papers 840, Society for Economic Dynamics.
    6. Equiza-Goñi, Juan, 2016. "Government debt maturity and debt dynamics in euro area countries," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 292-311.
    7. Hilscher, Jens & Raviv, Alon & Reis, Ricardo, 2014. "Inflating Away the Public Debt? An Empirical Assessment," CEPR Discussion Papers 10078, C.E.P.R. Discussion Papers.
    8. Scheer, Alexander, 2015. "Debt consolidation with long-term debt," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112874, Verein für Socialpolitik / German Economic Association.
    9. Juan Equiza Goni, 2014. "Sovereign Debt Maturity and Debt-to GDP Dynamics in Six Euro Area Countries," Working Papers ECARES ECARES 2014-44, ULB -- Universite Libre de Bruxelles.

    More about this item

    Keywords

    fiscal insurance; fiscal sustainability; government debt; inflation; interest rates; maturity;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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