Working Paper: NBER ID: w31297
Authors: Mark A. Aguiar; Manuel Amador; Cristina Arellano
Abstract: This paper explores the positive and normative consequences of government bond issuances in a New Keynesian model with heterogeneous agents, focusing on how the stock of government bonds affects the cross-sectional allocation of resources in the spirit of Samuelson (1958). We characterize the Pareto optimal levels of government bonds and the associated monetary policy adjustments that should accompany Pareto-improving bond issuances. The paper introduces a simple phase diagram to analyze the global equilibrium dynamics of inflation, interest rates, and labor earnings in response to changes in the stock of government debt. The framework also provides a tractable tool to explore the use of fiscal policy to escape the Effective Lower Bound (ELB) on nominal interest rates and the resolution of the “forward guidance puzzle.” A common theme throughout is that following the monetary policy guidance from the standard Ricardian framework leads to excess fluctuations in income and inflation.
Keywords: government bonds; New Keynesian model; Pareto improvements; monetary policy; fiscal policy
JEL Codes: E4; E60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government bond issuance (H63) | Pareto improvement in consumption allocation (D61) |
| Ricardian monetary policy (E62) | fluctuations in labor earnings and inflation (E31) |
| debt-financed tax cut announcement (H69) | increase in inflation (E31) |
| debt-financed tax cut announcement (H69) | increase in nominal interest rates (E43) |
| debt-financed tax cut announcement (H69) | increase in real interest rates (E43) |
| debt-financed tax cut announcement (H69) | increase in labor earnings (J39) |
| higher government debt (H63) | higher real interest rates (E43) |
| monetary authority adaptation (E49) | Pareto improvements (D61) |