A Taylor Rule for Public Debt

12 Pages Posted: 15 Sep 2016 Last revised: 17 Jul 2019

See all articles by Costas Azariadis

Costas Azariadis

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Date Written: 2016

Abstract

Public debt is an important source of liquidity in economies facing shortages of private credit. It is also a bubble whose current price depends on expectations of what it will buy at future dates. In this article, the author studies how the government must balance the provision of sufficient liquidity against the risk of adverse expectations regarding future debt prices when private liquidity has dried up. The socially optimal balance is captured in a Taylor-like rule that sets a target for real public debt and manages expectations by overreacting to deviations from the target value. Overreaction takes the form of manipulating budget surpluses to absorb excess debt or reverse liquidity shortages. A budget surplus (deficit) is equivalent to an income tax (subsidy) on investors that restrains (raises) their demand for liquid assets.

JEL Classification: E52, H60

Suggested Citation

Azariadis, Costas, A Taylor Rule for Public Debt (2016). Review, Vol. 98, Issue 3, pp. 227-38, 2016. Available at SSRN: https://ssrn.com/abstract=2839194 or http://dx.doi.org/10.20955/r.2016.227-238

Costas Azariadis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

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