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Crunch Time: Fiscal Crises and the Role of Monetary Policy

Author

Listed:
  • David Greenlaw
  • James D. Hamilton
  • Peter Hooper
  • Frederic S. Mishkin

Abstract

Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80% of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course. A potential fiscal crunch also puts fundamental limits on what monetary policy is able to achieve. In simulations of the Federal Reserve's balance sheet, we find that under our baseline assumptions, in 2017-18 the Fed will be running sizable income losses on its portfolio net of operating and other expenses and therefore for a time will be unable to make remittances to the U.S. Treasury. Under alternative scenarios that allow for an emergence of fiscal concerns, the Fed's net losses would be more substantial.

Suggested Citation

  • David Greenlaw & James D. Hamilton & Peter Hooper & Frederic S. Mishkin, 2013. "Crunch Time: Fiscal Crises and the Role of Monetary Policy," NBER Working Papers 19297, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:19297
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • 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
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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