FTPL and the Maturity Structure of Government Debt in the New-Keynesian Model

Abstract

How do skyrocketing debt-to-GDP ratios and government expenditures affect inflation and how does this depend on the maturity structure of sovereign debt? In this paper, we revisit the fiscal theory of the price level (FTPL) within the New Keynesian (NK) model. We show in which cases the maturity of government debt matters for the transmission of policy shocks. The central task of this paper is to shed light on the theoretical predictions of the maturity structure on macro dynamics with an emphasis on (expected) inflation. In particular, we show how fiscal- and monetary policy shocks affect interest rate and inflation dynamics. We highlight our results by quantifying the economic effects of the US COVID-19-emergency fiscal package (CARES), and shed light on the surge of inflation in the FTPL-NK model. In contrast, the CARES Act shocks have only small inflationary effects in the corresponding NK model with active monetary policy.

Keywords: NK models, FTPL, Government debt, Maturity structure, CARES

JEL Classification: E32, E12, C61