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Can passive monetary policy decrease the debt burden?

Author

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  • Mao, Ruoyun
  • Shen, Wenyi
  • Yang, Shu-Chun S.
Abstract
Large expansionary fiscal measures are often implemented with monetary accommodation during an economic crisis. When a government is highly indebted, and the timing of switching to the conventional regime M (passive fiscal/active monetary policies) is uncertain, a government spending increase in regime F (active fiscal/passive monetary policies) increases government debt. Such regime uncertainty dampens inflation and debt revaluation effects. Also, as regime uncertainty generates a smaller real interest rate decline, debt servicing costs fall less, and tax revenues increase less, than in the fixed regime F. These factors contribute to reversing the debt decline for a spending increase in the fixed regime F. The result holds under adverse supply shocks and potentially higher capital taxes, relevant factors in the post-COVID U.S. economy.

Suggested Citation

  • Mao, Ruoyun & Shen, Wenyi & Yang, Shu-Chun S., 2024. "Can passive monetary policy decrease the debt burden?," Journal of Economic Dynamics and Control, Elsevier, vol. 159(C).
    • Handle: RePEc:eee:dyncon:v:159:y:2024:i:c:s0165188923002087
    DOI: 10.1016/j.jedc.2023.104802
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    More about this item

    Keywords

    Passive monetary policy; Government spending effects; Endogenous regime-switching policy; Monetary and fiscal policy interaction; Nonlinear DSGE model;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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