Debt Nonneutrality, Policy Interactions, and Macroeconomic Stability

14 Pages Posted: 26 May 2010

See all articles by Ludger Linnemann

Ludger Linnemann

University of Dortmund

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Abstract

We study the consequences of nonneutrality of government debt for macroeconomic stabilization policy in a sticky-price model. Ricardian equivalence fails because debt has a negative impact on its rate of return and on private savings, which is induced by assuming transaction services of bonds. Under aggressive monetary policy regimes, macroeconomic fluctuations tend to be stabilized if nominal budget deficits are low. A smooth debt path limits inflation expectations, such that inflation variances can be reduced. Under a balanced budget policy, the central bank's output gap–inflation volatility trade-off is improved relative to an environment where debt is neutral.

Suggested Citation

Linnemann, Ludger and Schabert, Andreas, Debt Nonneutrality, Policy Interactions, and Macroeconomic Stability. International Economic Review, Vol. 51, Issue 2, pp. 461-474, May 2010. Available at SSRN: https://ssrn.com/abstract=1611957 or http://dx.doi.org/10.1111/j.1468-2354.2010.00588.x

Ludger Linnemann

University of Dortmund ( email )

Department of Economics
Dortmund, D-44221
Germany

Andreas Schabert

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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