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A Taylor Rule for Public Debt

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  • Costas Azariadis

Abstract

Public debt is an important source of liquidity in economies facing shortages of private credit. It is also a bubble whose current price depends on expectations of what it will buy at future dates. In this article, the author studies how the government must balance the provision of sufficient liquidity against the risk of adverse expectations regarding future debt prices when private liquidity has dried up. The socially optimal balance is captured in a Taylor-like rule that sets a target for real public debt and manages expectations by overreacting to deviations from the target value. Overreaction takes the form of manipulating budget surpluses to absorb excess debt or reverse liquidity shortages. A budget surplus (deficit) is equivalent to an income tax (subsidy) on investors that restrains (raises) their demand for liquid assets.

Suggested Citation

  • Costas Azariadis, 2016. "A Taylor Rule for Public Debt," Review, Federal Reserve Bank of St. Louis, vol. 98(3), pages 227-238.
  • Handle: RePEc:fip:fedlrv:00062
    DOI: 10.20955/r.2016.227-238
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    References listed on IDEAS

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    Cited by:

    1. Andolfatto, David & Martin, Fernando M., 2018. "Monetary policy and liquid government debt," Journal of Economic Dynamics and Control, Elsevier, vol. 89(C), pages 183-199.
    2. Batini, Nicoletta & Melina, Giovanni & Villa, Stefania, 2019. "Fiscal buffers, private debt, and recession: The good, the bad and the ugly," Journal of Macroeconomics, Elsevier, vol. 62(C).

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    More about this item

    JEL classification:

    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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