Optimal Fiscal and Monetary Policy, Debt Crisis and Management

By Cristiano Cantore, Paul L Levine, Giovanni Melina, Joseph G Pearlman

March 30, 2017

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Format: Chicago

Cristiano Cantore, Paul L Levine, Giovanni Melina, and Joseph G Pearlman. Optimal Fiscal and Monetary Policy, Debt Crisis and Management, (USA: International Monetary Fund, 2017) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

The initial government debt-to-GDP ratio and the government’s commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with “normal shocks”, perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds–under commitment–the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.

Subject: Asset and liability management, Bonds, Debt management, Expenditure, Financial institutions, Fiscal policy, Public debt

Keywords: Bonds, Debt consolidation, Debt management, Debt shock, Debt-deflating inflation volatility, Fiscal limits, GDP ratio, GDP scenario, Global, Government debt, Long-term debt, Monetary policy, Optimal fiscal-monetary policy, WP

Publication Details

Pages:

44
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2017/078
Stock No:

WPIEA2017078
ISBN:

9781475590180
ISSN:

1018-5941

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