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Central Bank Independence, Government Debt and the Re-Normalization of Interest Rates

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  • Tatiana Kirsanova
  • Campbell Leith
  • Ding Liu

Abstract

We develop a New Keynesian model augmented with a rich description of fiscal policy, including debt maturity structure, where two policymakers- an independent inflation-averse central bank and a (potentially) populist fiscal authority- interact strategically. Central bank independence initially improves inflation outcomes, but this results in reduced fiscal discipline and increased debt. Eventually this leads to inflation lying above pre-independence levels. Introducing a ‘flight-to-safety’ regime, which suppresses the interest rates households require to hold government debt, and a conventional regime, where their time preferences return to normal, allows us to explore how changes in the natural rate can dramatically affect debt dynamics and inflation outcomes. The model offers an explanation of the buildup of government debt since the financial crisis and the subsequent emergence of significant inflation

Suggested Citation

  • Tatiana Kirsanova & Campbell Leith & Ding Liu, 2024. "Central Bank Independence, Government Debt and the Re-Normalization of Interest Rates," Working Papers 2024_10, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2024_10
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    References listed on IDEAS

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    More about this item

    Keywords

    New Keynesian Model; Central Bank Independence; Government Debt; Monetary Policy; Fiscal Policy; Time Consistency.;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • 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

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