IDEAS home Printed from https://ideas.repec.org/p/ctl/louvir/2021018.html
   My bibliography  Save this paper

Debt Management in a World of Fiscal Dominance

Author

Listed:
  • Boris Chafwehé

    (Joint Research Centre European Commission)

  • Charles de Beauffort

    (National Bank of Belgium and IRES/LIDAM, UCLouvain)

  • Rigas Oikonomou

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

Abstract

We study the impact of debt maturity management in an economy where monetary policy is ’passive’ and subservient to fiscal policy. We setup a tractable model, to characterize analytically the dynamics of inflation, as well as other macroeconomic variables, showing their dependence on the monetary policy rule and on the maturity of debt. Debt maturity becomes a key variable when the monetary authority reacts to inflation and the appropriate maturity of debt can restore the efficacy of monetary policy in controlling inflation. This requires debt management to focus on issuing long bonds. Moreover, we propose a novel framework of Ramsey optimal coordinated debt and monetary policies, to derive analytically the interest rate rule followed by the monetary authority as a function of debt maturity. The optimal policy model leads to the same prescription, long term debt financing enables to stabilize inflation. Lastly, the relevance of debt maturity in reducing inflation variability is also confirmed in a medium scale DSGE model estimated with US data.

Suggested Citation

  • Boris Chafwehé & Charles de Beauffort & Rigas Oikonomou, 2021. "Debt Management in a World of Fiscal Dominance," LIDAM Discussion Papers IRES 2021018, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    • Handle: RePEc:ctl:louvir:2021018
    as

    Download full text from publisher

    File URL: https://sites.uclouvain.be/econ/DP/IRES/2021018.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Elisa Faraglia & Albert Marcet & Rigas Oikonomou & Andrew Scott, 2013. "The Impact of Debt Levels and Debt Maturity on Inflation," Economic Journal, Royal Economic Society, vol. 0, pages 164-192, February.
    2. Bouakez, Hafedh & Oikonomou, Rigas & Priftis, Romanos, 2018. "Optimal debt management in a liquidity trap," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 5-21.
    3. Francesco Bianchi & Leonardo Melosi, 2017. "Escaping the Great Recession," American Economic Review, American Economic Association, vol. 107(4), pages 1030-1058, April.
    4. Rigas Oikonomou & Albert Marcet & Elisa Faraglia, 2016. "Long term Government Bonds," 2016 Meeting Papers 565, Society for Economic Dynamics.
    5. Gauti Eggertsson & Bulat Gafarov & Saroj Bhatarai, 2014. "Time Consistency and the Duration of Government Debt: A Signalling Theory of Quantitative Easing," 2014 Meeting Papers 1292, Society for Economic Dynamics.
    6. Leeper, Eric M. & Leith, Campbell & Liu, Ding, 2021. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 600-617.
    7. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 531-554, April.
    8. Bhattarai, Saroj & Lee, Jae Won & Park, Woong Yong, 2014. "Inflation dynamics: The role of public debt and policy regimes," Journal of Monetary Economics, Elsevier, vol. 67(C), pages 93-108.
    9. Marco Del Negro & Marc P. Giannoni & Frank Schorfheide, 2015. "Inflation in the Great Recession and New Keynesian Models," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 168-196, January.
    10. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
    11. Anmol Bhandari & David Evans & Mikhail Golosov & Thomas J. Sargent, 2017. "Fiscal Policy and Debt Management with Incomplete Markets," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(2), pages 617-663.
    12. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
    13. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2017. "Optimal Time-Consistent Government Debt Maturity," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(1), pages 55-102.
    14. Hans J Blommestein & Philip Turner, 2012. "Interactions between sovereign debt management and monetary policy under fiscal dominance and financial instability," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 213-237, Bank for International Settlements.
    15. Sims, Christopher A., 2011. "Stepping on a rake: The role of fiscal policy in the inflation of the 1970s," European Economic Review, Elsevier, vol. 55(1), pages 48-56, January.
    16. Lustig, Hanno & Sleet, Christopher & Yeltekin, Sevin, 2008. "Fiscal hedging with nominal assets," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 710-727, May.
    17. Chiara Fratto & Harald Uhlig, 2020. "Accounting for Post-Crisis Inflation: A Retro Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 133-153, January.
    18. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
    19. George-Marios Angeletos, 2002. "Fiscal Policy with Noncontingent Debt and the Optimal Maturity Structure," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(3), pages 1105-1131.
    20. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Boris Chafwehé & Charles de Beauffort & Rigas Oikonomou, 2022. "Optimal Monetary Policy Rules in the Fiscal Theory of the Price Level," LIDAM Discussion Papers IRES 2022007, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    2. Boris Chafwehé & Rigas Oikonomou & Romanos Priftis & Lukas Vogel, 2021. "(Optimal) Monetary Policy with and without Debt," Staff Working Papers 21-5, Bank of Canada.
    3. Leeper, E.M. & Leith, C., 2016. "Understanding Inflation as a Joint Monetary–Fiscal Phenomenon," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2305-2415, Elsevier.
    4. Equiza-Goñi, Juan & Faraglia, Elisa & Oikonomou, Rigas, 2023. "Union debt management," Journal of International Money and Finance, Elsevier, vol. 130(C).
    5. Leeper, Eric M. & Zhou, Xuan, 2021. "Inflation’s role in optimal monetary-fiscal policy," Journal of Monetary Economics, Elsevier, vol. 124(C), pages 1-18.
    6. Max Ole Liemen & Olaf Posch, 2022. "FTPL and the Maturity Structure of Government Debt in the New Keynesian Model," CESifo Working Paper Series 9840, CESifo.
    7. Howard Kung & Gonzalo Morales & Alexandre Corhay, 2017. "Fiscal Discount Rates and Debt Maturity," 2017 Meeting Papers 840, Society for Economic Dynamics.
    8. Campbell Leith & Eric Leeper, 2016. "Understanding Inflation as a Joint Monetary-Fiscal Phenomenon," Working Papers 2016_01, Business School - Economics, University of Glasgow.
    9. Boris Chafwehe Author-Email: boris.chafwehe@uclouvain.be & Rigas Oikonomou & Romanos Priftis & Lukas Vogel, 2018. "Endogenous forward guidance," Working Paper Research 354, National Bank of Belgium.
    10. Leeper, Eric M. & Leith, Campbell & Liu, Ding, 2021. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 600-617.
    11. Guillermo Santos, 2022. "Optimal fiscal and monetary policy with preference over safe assets," LIDAM Discussion Papers IRES 2022021, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    12. Guillermo Santos, 2022. "Optimal fiscal policy and the Fiscal Theory of the Price Level," LIDAM Discussion Papers IRES 2022022, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    13. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2021. "Optimal Fiscal Policy without Commitment: Revisiting Lucas-Stokey," Journal of Political Economy, University of Chicago Press, vol. 129(5), pages 1640-1665.
    14. Bouakez, Hafedh & Oikonomou, Rigas & Priftis, Romanos, 2018. "Optimal debt management in a liquidity trap," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 5-21.
    15. Adao, Bernardino & Correia, Isabel & Teles, Pedro, 2009. "On the relevance of exchange rate regimes for stabilization policy," Journal of Economic Theory, Elsevier, vol. 144(4), pages 1468-1488, July.
    16. Marco Bassetto & Thomas J. Sargent, 2020. "Shotgun Wedding: Fiscal and Monetary Policy," Annual Review of Economics, Annual Reviews, vol. 12(1), pages 659-690, August.
    17. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2022. "The Commitment Benefit of Consols in Government Debt Management," American Economic Review: Insights, American Economic Association, vol. 4(2), pages 255-270, June.
    18. Basil Guggenheim & Mario Meichle & Thomas Nellen, 2019. "Confederation debt management since 1970," Swiss Journal of Economics and Statistics, Springer;Swiss Society of Economics and Statistics, vol. 155(1), pages 1-23, December.
    19. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2018. "Optimal Fiscal Policy without Commitment: Beyond Lucas-Stokey," NBER Working Papers 24522, National Bureau of Economic Research, Inc.
    20. Saki Bigio & Galo Nuño & Juan Passadore, 2019. "A framework for debt-maturity management," Working Papers 1919, Banco de España.

    More about this item

    Keywords

    Passive monetary policy; Govenment debt management; Fiscal and monetary policy interactions; Bayesian estimation; Ramsey policy;
    All these keywords.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ctl:louvir:2021018. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Virginie LEBLANC (email available below). General contact details of provider: https://edirc.repec.org/data/iruclbe.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.