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Debt Management in a World of Fiscal Dominance

Author

Listed:
  • Boris Chafwehé

    (Joint Research Centre European Commission)

  • Charles de Beauffort

    (National Bank of Belgium and IRES/LIDAM, UCLouvain)

  • Rigas Oikonomou

    (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

Abstract

We study the impact of debt maturity management in an economy where monetary policy is ’passive’ and subservient to fiscal policy. We setup a tractable model, to characterize analytically the dynamics of inflation, as well as other macroeconomic variables, showing their dependence on the monetary policy rule and on the maturity of debt. Debt maturity becomes a key variable when the monetary authority reacts to inflation and the appropriate maturity of debt can restore the efficacy of monetary policy in controlling inflation. This requires debt management to focus on issuing long bonds. Moreover, we propose a novel framework of Ramsey optimal coordinated debt and monetary policies, to derive analytically the interest rate rule followed by the monetary authority as a function of debt maturity. The optimal policy model leads to the same prescription, long term debt financing enables to stabilize inflation. Lastly, the relevance of debt maturity in reducing inflation variability is also confirmed in a medium scale DSGE model estimated with US data.

Suggested Citation

  • Boris Chafwehé & Charles de Beauffort & Rigas Oikonomou, 2021. "Debt Management in a World of Fiscal Dominance," LIDAM Discussion Papers IRES 2021018, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    • Handle: RePEc:ctl:louvir:2021018
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    More about this item

    Keywords

    Passive monetary policy; Govenment debt management; Fiscal and monetary policy interactions; Bayesian estimation; Ramsey policy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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