Dynamic Debt Deleveraging and Optimal Monetary Policy

55 Pages Posted: 18 Apr 2016

See all articles by Pierpaolo Benigno

Pierpaolo Benigno

Luiss Guido Carli University; Einaudi Institute for Economics and Finance (EIEF)

Gauti B. Eggertsson

Federal Reserve Bank of New York

Federica Romei

Luiss Guido Carli University

Multiple version iconThere are 2 versions of this paper

Date Written: March 2016

Abstract

This paper studies optimal monetary policy under dynamic debt deleveraging once the zero bound is binding. Unlike much of the existing literature, the natural rate of interest is endogenous and depends on macroeconomic policy. We provide microfoundation for debt deleveraging based both on household over accumulation of debt and leverage constraint on banks; and show that they are isomorphic in our proposed post-crisis New Keynesian model, thus integrating two popular narrative for the crisis. Optimal monetary policy successfully raises the natural rate of interest by creating an environment that speeds up deleveraging, thus endogenously shortening the duration of the crisis and a binding zero bound. Inflation should be front loaded. Fiscal-policy multipliers can be even higher than in existing models, but depend on the way in which public spending is financed.

Suggested Citation

Benigno, Pierpaolo and Eggertsson, Gauti B. and Romei, Federica, Dynamic Debt Deleveraging and Optimal Monetary Policy (March 2016). CEPR Discussion Paper No. DP11180. Available at SSRN: https://ssrn.com/abstract=2766475

Pierpaolo Benigno (Contact Author)

Luiss Guido Carli University

Viale Romania 32
Rome, Roma 00197
Italy

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Gauti B. Eggertsson

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Federica Romei

Luiss Guido Carli University ( email )

Via O. Tommasini 1
Rome, Roma 00100
Italy

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