Monetary Policy and Debt Fragility

45 Pages Posted: 3 Nov 2014

See all articles by Antoine Camous

Antoine Camous

European University Institute

Russell Cooper

University of Texas at Austin - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: October 2014

Abstract

The valuation of government debt is subject to strategic uncertainty, stemming from investors' sentiments. Pessimistic lenders, fearing default, bid down the price of debt. This leaves a government with a higher debt burden, increasing the likelihood of default and thus confirming the pessimism of lenders. This paper studies the interaction of monetary policy and debt fragility. It asks: do monetary interventions mitigate debt fragility? The answer depends in part on the nature of monetary policy, particularly the ability of the monetary authority to commit to future state contingent actions. With commitment to a state contingent policy, the monetary authority can indeed overcome strategic uncertainty. Under discretion, debt fragility remains unless reputation effects are sufficiently strong.

Suggested Citation

Camous, Antoine and Cooper, Russell W., Monetary Policy and Debt Fragility (October 2014). NBER Working Paper No. w20650. Available at SSRN: https://ssrn.com/abstract=2518740

Antoine Camous (Contact Author)

European University Institute ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Russell W. Cooper

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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