Discount Rates, Debt Maturity, and the Fiscal Theory
61 Pages Posted: 9 Aug 2021
Date Written: July 22, 2021
This paper examines how the transmission of government portfolio risk arising from maturity operations depends on the stance of monetary/fiscal policy. Accounting for risk premia in the fiscal theory allows the government portfolio to affect the expected inflation, even in a frictionless economy. The effects of maturity rebalancing on expected inflation in the fiscal theory directly depend on the conditional nominal term premium, giving rise to an optimal debt maturity policy that is state dependent. In a calibrated macro-finance model, we demonstrate that maturity operations have sizable effects on expected inflation and output through our novel risk transmission mechanism.
Keywords: Term structure of interest rates, Fiscal theory of the price level, Bond risk premia, Government debt, DSGE models, Nonlinear solution methods
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