OPTIMAL FISCAL AND MONETARY POLICY, DEBT CRISIS, AND MANAGEMENT. (20th July 2017)

• Record Type: Journal Article
• Authors: Cantore, Cristiano; Levine, Paul; Melina, Giovanni; Pearlman, Joseph
• Is Part Of: Macroeconomic dynamics. Volume 23:Number 3(2019)
• Page Start: 1166
• Page End: 1204
• Publication Date: 2017-07-20
• Subjects: Optimal Fiscal–Monetary Policy, -- Ramsey Policy, -- Time-Consistent Policy, -- Optimized Simple Rules, -- Debt Consolidation, -- Long-Term Debt, -- Fiscal Limits, -- Sovereign Default Risk; Macroeconomics -- Periodicals; 339.05
• DOI: 10.1017/S1365100517000207
• Languages: English
• ISSNs: 1365-1005

Abstract

Abstract : The initial government debt-to-gross domestic product (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-GDP 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.