The International Transmission of Monetary Policy in Presence of Government Debt: A GVAR Approach

Posted: 29 Dec 2016

Date Written: July 29, 2013

Abstract

This paper aims to contribute to the empirical literature on the international spillovers of US monetary policy, whilst accounting for fiscal policy. The main motivation of the paper is to identify the way in which fiscal policy is able to influence the monetary transmission mechanism and generate international spillovers. Here we model fiscal policy using government debt levels. Moreover, the study addresses the extent to which an increase in US government debt can stimulate the real economy and generate spillovers to the other economies. When modelling fiscal policy in open economy context we account for potential import leakages by employing a Global Vector Autoregressive (GVAR) methodology, which captures trade linkages across countries. Thus, it more fully models fiscal policy implemented in a global context and accounts for policy spillovers. The Generalized Impulse Response Functions (GIRF) indicates that accounting for fiscal policy influences the impact of a monetary contraction. Given the high level of US government debt, this finding seems to be reasonable, as any changes in interest rates can change the interest expenses share of government expenditure significantly. Furthermore, the response to an expansionary fiscal policy supports the non-Ricardian view on fiscal policy within US economy that is it increases both inflation and output. This fiscal policy shock also appears to generate expansionary spillover effects on other economies. Moreover, according to the estimated Likelihood Ratio (LR) to examine the potential contribution of US government debt to long-run macroeconomic relations within the GVAR, evidence suggests that the unrestricted Fisher equation, the Term Premium, and the Uncovered Interest Rate Parities (UIP) condition can be maintained for the US and other economies. Finally, the results of Persistence Profiles (PP) proposed by Pesaran and Shin (1996) suggest that government debt induces a decrease in the convergence rate to equilibrium following the policy shocks compared with alternative model specifications.

Keywords: Monetary and Fiscal Policy; International Spillovers; Government Debt; Global VAR; Generalized Impulse Response Functions; Long-Run Macroeconomic Relations

JEL Classification: E470, H690, C510, C520, C530

Suggested Citation

Assadi, Marzieh, The International Transmission of Monetary Policy in Presence of Government Debt: A GVAR Approach (July 29, 2013). Available at SSRN: https://ssrn.com/abstract=2891295

Marzieh Assadi (Contact Author)

Shahid Beheshti University ( email )

Evin St- No1.
Tehran, Tehran
989151022202 (Phone)

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