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Deteriorating Public Finances and Rising Government Debt: Implications for Monetary Policy

Author

Listed:
  • Lillian Cheung

    (Research Department, Hong Kong Monetary Authority)

  • Chi-Sang Tam

    (Research Department, Hong Kong Monetary Authority)

  • Jessica Szeto

    (Research Department, Hong Kong Monetary Authority)

Abstract

The sharp rise in government debt in many major economies following the introduction of large fiscal stimulus measures during the global financial crisis of 2008-09 has triggered concerns over its impact on long-term interest rates and the potential negative consequences for future growth and inflation. This paper uses an error-correction model to assess the effect of growing government debt on long-term real interest rates by drawing on empirical evidence from the US. The results show that in the long run, a one-percentage-point increase in the federal debt-to-GDP ratio raises the equilibrium 10-year real US Treasury yield by about six basis points. We also discuss the economic consequences of a rise in the world long-term interest rates, and draw implications for longer-term growth and the conduct of monetary policy in the Asian economies.

Suggested Citation

  • Lillian Cheung & Chi-Sang Tam & Jessica Szeto, 2009. "Deteriorating Public Finances and Rising Government Debt: Implications for Monetary Policy," Working Papers 0915, Hong Kong Monetary Authority.
    • Handle: RePEc:hkg:wpaper:0915
    as

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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP09_15_full.pdf
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    References listed on IDEAS

    as
    1. Anne-Marie Brook, 2003. "Recent and Prospective Trends in Real Long-Term Interest Rates: Fiscal Policy and other Drivers," OECD Economics Department Working Papers 367, OECD Publishing.
    2. Joseph E. Gagnon, 1996. "Net foreign assets and equilibrium exchange rates: panel evidence," International Finance Discussion Papers 574, Board of Governors of the Federal Reserve System (U.S.).
    3. Zhiwei Zhang & Wenlang Zhang & Gaofeng Han, 2009. "How Does the US Credit Crisis Affect the Asia-Pacific Economies? --- Analysis based on a General Equilibrium Model," Working Papers 0912, Hong Kong Monetary Authority.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Zhang, Zhiwei & Zhang, Wenlang, 2011. "The road to recovery: Fiscal stimulus, financial sector rehabilitation, and potential risks ahead," Journal of Asian Economics, Elsevier, vol. 22(4), pages 311-321, August.
    2. Zhang, Wenlang & Zhang, Zhiwei & Han, Gaofeng, 2010. "How does the US credit crisis affect the Asia-Pacific economies?--Analysis based on a general equilibrium model," Journal of Asian Economics, Elsevier, vol. 21(3), pages 280-292, June.
    3. Zhiwei Zhang & Wenlang Zhang & Gaofeng Han, 2009. "How Does the US Credit Crisis Affect the Asia-Pacific Economies? --- Analysis based on a General Equilibrium Model," Working Papers 0912, Hong Kong Monetary Authority.

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    More about this item

    Keywords

    Public debt; fiscal policy; monetary policy; long term interest rate; real interest rate; error-correction model;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • 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; Modern Monetary Theory
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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