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Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability

  • Ludger Linnemann
  • Andreas Schabert

We study the consequences of non-neutrality of government debt with respect to aggregate demand for short-run macroeconomic stability and for fiscal-monetary policy interactions in an environment where prices are sticky. Assuming either transaction services of government bonds or partial debt repayments, Ricardian equivalence fails because public debt has a negative impact on its total rate of return and thus on private savings. Equilibrium stability then requires real public debt to be stationary, which steers future expectations about prices and output, and rules out self-fulfilling expectations. Under aggressive anti-inflationary monetary policy regimes, macroeconomic fluctuations can then decrease with the share of tax financing. In particular, a balanced budget policy stabilizes the economy under cost-push shocks such that output and inflation variances can be lower than in a corresponding framework where debt is neutral.

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Paper provided by University of Cologne, Department of Economics in its series Working Paper Series in Economics with number 12.

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Date of creation: 17 Sep 2004
Date of revision:
Handle: RePEc:kls:series:0012
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