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The maturity structure of debt, monetary policy and expectations stabilization

Author

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  • Bruce Preston

    (Columbia University and NBER)

  • Stefano Eusepi

    (Federal Reserve bank of New York)

Abstract

This paper identifies a channel by which changes in the size and composition of government debt might generate macroeconomic instability in a standard New Keynesian model. The mechanism depends on failures of Ricardian equivalence because of learning dynamics. Under rational expectations, the model has the prediction that Ricardian equivalence holds, and the scale and composition of public debt held by households is irrelevant to the determination of inflation and output. Under learning, holdings of the public debt are perceived as net wealth, with the resulting expenditure effects shown to be destabilizing, depending on both the scale and composition of the public debt. Very short and long average debt maturities are conducive to stability, while short-to-medium average maturities tend to generate instability in the sense that much more aggressive monetary policy is required to prevent divergent learning dynamics. More heavily indebted economies are more sensitive to adjustments in maturity structure. This suggests there might be considerations, aside from the presumed stimulus from large-scale asset purchases via lower longer-term interest rates, that are relevant to evaluating recent proposals for further quantitative easing in the United States.

Suggested Citation

  • Bruce Preston & Stefano Eusepi, 2011. "The maturity structure of debt, monetary policy and expectations stabilization," 2011 Meeting Papers 1287, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:1287
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    File URL: https://economicdynamics.org/meetpapers/2011/paper_1287.pdf
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    References listed on IDEAS

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    2. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    3. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    4. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
    5. John Y. Campbell & Robert J. Shiller, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Oxford University Press, vol. 58(3), pages 495-514.
    6. Richard H. Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    7. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-417, June.
    8. Robert E. Hall, 2009. "Reconciling Cyclical Movements in the Marginal Value of Time and the Marginal Product of Labor," Journal of Political Economy, University of Chicago Press, vol. 117(2), pages 281-323, April.
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    Cited by:

    1. Francesco Bianchi & Leonardo Melosi, 2014. "Dormant Shocks and Fiscal Virtue," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 1-46.

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