Optimal Fiscal and Monetary Policy, Debt Crisis and Management

45 Pages Posted: 12 May 2017

See all articles by Cristiano Cantore

Cristiano Cantore

University of Surrey; Bank of England

Paul Levine

School of Economics, University of Surrey

Giovanni Melina

International Monetary Fund (IMF)

Joseph Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB)

Date Written: March 2017

Abstract

The initial government debt-to-GDP ratio and the government's commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with 'normal shocks', perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds - under commitment - the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.

Keywords: Crisis management, Debt consolidation, Optimal fiscal-monetary policy, long-term debt, fiscal limits, Monetary Policy (Targets, Instruments, and Effects)

JEL Classification: E52, E62, H12, H63

Suggested Citation

Cantore, Cristiano and Levine, Paul L. and Melina, Giovanni and Pearlman, Joseph G., Optimal Fiscal and Monetary Policy, Debt Crisis and Management (March 2017). IMF Working Paper No. 17/78. Available at SSRN: https://ssrn.com/abstract=2967433

Cristiano Cantore (Contact Author)

University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Paul L. Levine

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Giovanni Melina

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Joseph G. Pearlman

London Metropolitan University - Department of Economics, Finance and International Business (EFIB) ( email )

Economics Subject Group, LMBS
London EC2M 6SQ, EC2M 6SQ
United Kingdom

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