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The incentive effects of monetary policy on fiscal policy behaviour

Author

Listed:
  • Röttger, Joost
  • Gerke, Rafael

Abstract

How do prolonged low-interest-rate episodes affect fiscal discipline? This paper investigates this question by using a quantitative model with endogenous public debt management and sovereign default. Following a persistent interest rate reduction, sovereign risk and government bond yields decline. An impatient fiscal policy maker responds to improved financing conditions by relaxing its policy stance and accumulating more debt. Due to the increased debt burden, a subsequent interest rate reversal can put substantial pressure on the public budget, raising the likelihood of default. The longer the interest rate cut is expected to last, the more pronounced the fiscal response will be.

Suggested Citation

  • Röttger, Joost & Gerke, Rafael, 2021. "The incentive effects of monetary policy on fiscal policy behaviour," Technical Papers 04/2021, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubtps:283327
    as

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    File URL: https://www.econstor.eu/bitstream/10419/283327/1/technical-paper-2021-04.pdf
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    References listed on IDEAS

    as
    1. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Quantitative properties of sovereign default models: solution methods," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(4), pages 919-933, October.
    2. Gauti Eggertsson & Sergey Egiev & Alessandro Lin & Josef Platzer & Luca Riva, 2021. "A Toolkit for Solving Models with a Lower Bound on Interest Rates of Stochastic Duration," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 41, pages 121-173, July.
    3. Satyajit Chatterjee & Dean Corbae & Kyle Dempsey & José‐Víctor Ríos‐Rull, 2023. "A Quantitative Theory of the Credit Score," Econometrica, Econometric Society, vol. 91(5), pages 1803-1840, September.
    4. Alberto Alesina & Guido Tabellini, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 57(3), pages 403-414.
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    More about this item

    Keywords

    Public Debt; Sovereign Risk; Low-Interest-Rate Policies;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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