This site is for archive purposes. Please visit for latest updates
Go to Top

Optimal Fiscal and Monetary Policy, Debt Crisis and Management

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