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- 17 April 2019
- WORKING PAPER SERIES - No. 2268Details
- This paper analyzes the impact of monetary policy on public debt sustainability through the lens of a general equilibrium model with fiscal limits. We find that the mere possibility of a binding ZLB may have detrimental effects on debt sustainability, as a kink in the Laffer curve induces a dead-weight loss in the present discounted value of future primary surpluses. Moreover, debt sustainability improves with monetary policy activeness, that is, with the elasticity of the interest rate to changes in inflation and the output gap. On this basis, we assess the trade-off between economic stabilization and debt sustainability depending on the monetary policy environment. In normal times, large public spending shocks may engender perverse debt dynamics and cause economic contractions. At the ZLB, a muted trade-off between stabilization and sustainability instead expands the fiscal margin, especially if coupled with a commitment to a more active monetary policy during normal times.
- JEL Code
- E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy
E61 : Macroeconomics and Monetary Economics→Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook→Policy Objectives, Policy Designs and Consistency, Policy Coordination
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