Working Paper: NBER ID: w25996
Authors: Rashad Ahmed; Joshua Aizenman; Yothin Jinjarak
Abstract: Countries have significantly increased their public-sector borrowing since the Global Financial Crisis. As a consequence, monetary authorities may face pressure to deviate from their policy targets in ways designed to ease the debt burden. In this context, we test for greater fiscal dominance over 2000-2017 under Inflation Targeting (IT) and non-IT regimes. We find that evidence consistent with fiscal dominance varies across countries and debt configurations. Higher ratios of public debt-to-GDP may appear associated with lower policy interest rates in advanced economies. However, a declining natural rate of interest largely explains the pattern of lower rates and higher debt in these countries. The most robust evidence of fiscal dominance lies among emerging markets under non-IT regimes, composed mostly of exchange rate targeters. For these countries, policy interest rates are non-linearly associated with public debt levels, depending on both the level of hard-currency public debt-to-GDP and the currency composition of public debt. We also show that emerging market economies with greater exchange rate volatility, inflation volatility, and underlying commodity exposure exhibit stronger associations between public debt and policy interest rates.
Keywords: Fiscal Dominance; Monetary Policy; Public Debt; Inflation Targeting; Exchange Rate Targeting
JEL Codes: F31; F33; F34; F36; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| public debt-to-GDP ratios (H63) | policy interest rates (E43) |
| higher levels of public debt-to-GDP ratios (H69) | lower policy interest rates (E43) |
| foreign currency public debt-to-GDP ratios (F31) | policy interest rates (E43) |
| fiscal dominance (E62) | influence of public debt on monetary policy (E62) |
| exchange rate volatility and commodity exposure (F31) | fiscal dominance (E62) |