Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability

Tinbergen Institute Discussion Paper No. 05-077/2

29 Pages Posted: 15 Aug 2005

See all articles by Ludger Linnemann

Ludger Linnemann

University of Cologne - Department of Economics

Andreas Schabert

University of Cologne - Department of Economics; University of Dortmund; University of Amsterdam - Faculty of Economics and Business

Date Written: July 27, 2005

Abstract

We study the consequences of non-neutrality of government debt for macroeconomic stabilization policy in an environment where prices are sticky. Assuming transaction services of government bonds, Ricardian equivalence fails because public debt has a negative impact on its marginal rate of return and thus on private savings. Stability of equilibrium sequences requires a stationary evolution of real public debt, which steers inflation expectations and rules out endogenous fluctuations. Under anti-inflationary monetary policy regimes, macroeconomic fluctuations tend to decrease with the share of tax financing, which justifies tight debt constraints. In particular, a balanced budget policy stabilizes the economy under cost-push shocks, such that output and inflation variances can be lower than in a corresponding case where debt is neutral.

Keywords: Government debt, fiscal and monetary policy rules, stabilization policy, equilibrium uniqueness

JEL Classification: E32, E63, E52

Suggested Citation

Linnemann, Ludger and Schabert, Andreas, Debt Non-Neutrality, Policy Interactions, and Macroeconomic Stability (July 27, 2005). Tinbergen Institute Discussion Paper No. 05-077/2. Available at SSRN: https://ssrn.com/abstract=776324 or http://dx.doi.org/10.2139/ssrn.776324

Ludger Linnemann

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany
+49-221-470-2999 (Phone)
+49-221-470-5077 (Fax)

Andreas Schabert (Contact Author)

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

University of Dortmund ( email )

Vogelpothsweg 87
Dortmund, 44227
Germany
+49 231 755 3288 (Phone)

University of Amsterdam - Faculty of Economics and Business ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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