Crunch Time: Fiscal Crises and the Role of Monetary Policy

94 Pages Posted: 10 Aug 2013

See all articles by David Greenlaw

David Greenlaw

Morgan Stanley

James D. Hamilton

University of California at San Diego; National Bureau of Economic Research (NBER)

Peter Hooper

Deutsche Bank Securities, Inc. - Global Markets Research, Economy

Frederic S. Mishkin

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: August 2013

Abstract

Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80% of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course. A potential fiscal crunch also puts fundamental limits on what monetary policy is able to achieve. In simulations of the Federal Reserve's balance sheet, we find that under our baseline assumptions, in 2017-18 the Fed will be running sizable income losses on its portfolio net of operating and other expenses and therefore for a time will be unable to make remittances to the U.S. Treasury. Under alternative scenarios that allow for an emergence of fiscal concerns, the Fed's net losses would be more substantial.

Suggested Citation

Greenlaw, David and Hamilton, James D. and Hooper, Peter and Mishkin, Frederic S., Crunch Time: Fiscal Crises and the Role of Monetary Policy (August 2013). NBER Working Paper No. w19297. Available at SSRN: https://ssrn.com/abstract=2308266

David Greenlaw (Contact Author)

Morgan Stanley ( email )

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James D. Hamilton

University of California at San Diego ( email )

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619-534-5986 (Phone)
619-534-7040 (Fax)

National Bureau of Economic Research (NBER)

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Peter Hooper

Deutsche Bank Securities, Inc. - Global Markets Research, Economy ( email )

60 Wall Street
Mail Stop: NYC60-1815
New York, NY 10005
United States

Frederic S. Mishkin

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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