Optimal time-consistent monetary, fiscal and debt maturity policy

Leeper, E. M., Leith, C. and Liu, D. (2021) Optimal time-consistent monetary, fiscal and debt maturity policy. Journal of Monetary Economics, 117, pp. 600-617. (doi: 10.1016/j.jmoneco.2020.03.015)

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The textbook optimal policy response to an increase in government debt is simple—monetary policy should actively target inflation, and fiscal policy should smooth taxes while ensuring debt sustainability. Such policy prescriptions presuppose an ability to commit. Without that ability, the temptation to use inflation surprises to offset monopoly and tax distortions, as well as to reduce the real value of government debt, creates a state-dependent inflationary bias problem. High debt levels and short-term debt exacerbate the inflation bias. But this produces a debt stabilization bias because the policy maker wishes to deviate from the tax smoothing policies typically pursued under commitment, by returning government debt to steady-state. As a result, the response to shocks in New Keynesian models can be radically different, particularly when government debt levels are high and maturity short.

Item Type:Articles
Glasgow Author(s) Enlighten ID:Leith, Professor Campbell
Authors: Leeper, E. M., Leith, C., and Liu, D.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Journal of Monetary Economics
ISSN (Online):1873-1295
Published Online:09 April 2020
Copyright Holders:Copyright © 2020 Elsevier
First Published:First published in Journal of Monetary Economics 117:600-617
Publisher Policy:Reproduced in accordance with the copyright policy of the publisher

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