Working Paper: NBER ID: w19686
Authors: Eric M. Leeper; Xuan Zhou
Abstract: We study how the maturity structure of nominal government debt affects optimal monetary and fiscal policy decisions and equilibrium outcomes in the presence of distortionary taxes and sticky prices. Key findings are: (1) there is always a role for current and future inflation innovations to revalue government debt, reducing reliance on distorting taxes; (2) the role of inflation in optimal fiscal financing increases with the average maturity of government debt; (3) as average maturity rises, it is optimal to tradeoff inflation for output stabilization; (4) inflation is relatively more important as a fiscal shock absorber in high-debt than in low-debt economies; (5) in some calibrations that are relevant to U.S. data, welfare under the fully optimal monetary and fiscal policies can be made equivalent to the welfare under the conventional optimal monetary policy with passively adjusting lump-sum taxes by extending the average maturity of bond.
Keywords: Inflation; Monetary Policy; Fiscal Policy; Government Debt
JEL Codes: E31; E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current and future inflation innovations (E31) | government debt valuation (H63) |
| inflation (E31) | fiscal financing (E62) |
| average maturity of government debt (H63) | inflation (E31) |
| average maturity of government debt (H63) | trade-off between inflation and output stabilization (E63) |
| level of debt (F34) | impact of inflation on fiscal stability (E62) |
| average maturity of bonds (G12) | welfare outcomes (I38) |