Cantore, Cristiano, Melina, Giovanni, Pearlman, Joseph G, Levine, Paul L, (2017), “Optimal Fiscal and Monetary Policy, Debt Crisis and Management”, IMF Working Paper 17/78, 30 March
The initial government debt-to-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-GPD 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.
Relevant Posts
- Hagan, Sean, Obstfeld, Maurice, Thomsen, Poul M., (2017), “Dealing with Sovereign Debt—The IMF Perspective”, iMFdirect, 23 February
- Batini, Nicoletta, Melina, Giovanni, Moreno Badia, Marialuz, Villa, Stefania, (2017), “The Role of Fiscal Policy When Private Debt is High”, EconoMonitor, 15 March