The 'Mystery of the Printing Press' Monetary Policy and Self-Fulfilling Debt Crises

51 Pages Posted: 17 Feb 2016

See all articles by Giancarlo Corsetti

Giancarlo Corsetti

University of Cambridge; University of Rome III - Department of Economics; Centre for Economic Policy Research (CEPR)

Luca Dedola

Bank of Italy; European Central Bank (ECB)

Date Written: February 2016


We study the mechanism by which unconventional (balance-sheet) monetary policy can rule out self-fulfilling sovereign default in a model with optimizing but discretionary fiscal and monetary policymakers. By purchasing sovereign debt, the central bank effectively swaps risky government paper for monetary liabilities only exposed to inflation risk, thus yielding a lower interest rate. We characterize a critical threshold for central bank purchases beyond which, absent fundamental fiscal stress, the government strictly prefers primary surplus adjustment to default. Since default may still occur for fundamental reasons, however, the central bank faces the risk of losses on sovereign debt holdings, which may generate inefficient inflation. This risk does not undermine the credibility of a backstop, nor the ability of a central bank to pursue its inflation objectives when the latter enjoys fiscal backing or fiscal authorities are sufficiently averse to inflation.

Keywords: Inflationary financing, Lender of last resort, Seigniorage, Sovereign risk and default

JEL Classification: E58, E63, H63

Suggested Citation

Corsetti, Giancarlo and Dedola, Luca, The 'Mystery of the Printing Press' Monetary Policy and Self-Fulfilling Debt Crises (February 2016). CEPR Discussion Paper No. DP11089, Available at SSRN:

Giancarlo Corsetti (Contact Author)

University of Cambridge ( email )

University of Rome III - Department of Economics ( email )

via Ostiense 139
Rome, 00154
+39 06 5737 4056 (Phone)
+39 06 5737 4093 (Fax)

Centre for Economic Policy Research (CEPR)

United Kingdom

Luca Dedola

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

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