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The Effectiveness of Government Debt for Demand Management: Sensitivity to Monetary Policy Rules

  • Guido Ascari
  • Neil Rankin

We construct a staggered-price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make an increase in government debt, with associated changes in lump-sum taxation, effective in raising short-run output. However we find this is very sensitive to the monetary policy rule. A permanent increase in debt under a basic Taylor Rule does not raise output. To make debt effective we need either a temporary nominal interest rate peg; or inertia in the rule; or an exogenous money supply policy; or to make the debt increase temporary.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 10/25.

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Date of creation: Dec 2010
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Handle: RePEc:yor:yorken:10/25
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