Can Monetary Policy Create Fiscal Capacity?

Vadim Elenev, Tim Landvoigt, Patrick J. Shultz and Stijn Van Nieuwerburgh

No 29129, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Governments around the world have gone on a massive fiscal expansion in response to the Covid crisis, increasing government debt to levels not seen in 75 years. How will this debt be repaid? What role do conventional and unconventional monetary policy play? We investigate debt sustainability in a New Keynesian model with an intermediary sector, realistic fiscal and monetary policy, endogenous convenience yields, and substantial risk premia. When conventional monetary policy is constrained by the ZLB during an economic crisis, increased government spending and lower tax revenue lead to a large rise in government debt and raise the risk of future tax increases. We find that quantitative easing (QE), forward guidance, and an expansion in government discretionary spending all contribute to lowering debt/GDP ratio and reducing this fiscal risk. A transitory QE policy deployed during a crisis stimulates aggregate demand.

JEL-codes: E1 E12 E13 E2 E31 E32 E37 E4 E42 E43 E44 E6 E62 E63 G12 G18 G21 (search for similar items in EconPapers)
Date: 2021-08
New Economics Papers: this item is included in nep-cba, nep-dge, nep-isf, nep-mac and nep-mon
Note: AP EFG ME
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Citations: View citations in EconPapers (7)

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