Public Debt Dynamics in Selected OECD Countries: The Role of Fiscal Stabilisation and Monetary Policy
40 Pages Posted: 14 Feb 2012
Date Written: March 29, 2007
Shocks to monetary and fiscal policy have played a major role in public debt developments since the mid 1970s. According to the applied VAR approach, together these shocks explained, on average, about half of the forecast error variation in the debt to GDP ratio while the share of shocks to GDP growth was close to 30 percent. Instead, shocks to inflation and the debt ratio itself played in most cases a minor role. However, the inflation shocks were vital in initiating the public debt problems as the increase in actual inflation and particularly the persistence of high inflation expectations in the 1980s led to a prolonged period of high real interest rates. This gave rise to ‘some unpleasant fiscal arithmetic’ which aggravated debt problems. In most countries fiscal policy has aimed at correcting the deterioration of fiscal balances, but the progress has in most cases been slow and delayed. Nevertheless, all individual country VARs are stable in the period under consideration. Finally, contrary to general beliefs, in the global financial markets of present day inflation makes debt problems worse through its adverse impact on interest rates.
Keywords: public debt dynamics, fiscal policy, monetary policy, VAR models
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