Precautionary Monetary and Fiscal Policies

29 Pages Posted: 21 Feb 2007

See all articles by Pelin Berkmen

Pelin Berkmen

International Monetary Fund (IMF)

Date Written: February 2007

Abstract

This paper explains why the debt reduction motive for countries that are subject to borrowing constraints and a volatile environment is greater than for those with a more stable environment and relatively better access to the financial markets. In particular, it shows that the possibility of losing the ability to borrow in the future induces precautionary debt reduction. When a government loses its ability to borrow, shocks are more costly to the economy, since they cannot be spread over time. The precautionary motive arises from the need to make these adjustments less painful when the borrowing constraints bind. To avoid large losses in the constrained period, the government prefers to raise taxes and inflation in earlier periods more than would be implied otherwise, leaving less debt to the future periods, and thereby shifting some of the required adjustment to the earlier periods. In other words, the coexistence of large shocks and borrowing constraints forces the government to be more prudent in its management of debt.

JEL Classification: E52, E62, H63

Suggested Citation

Berkmen, S. Pelin, Precautionary Monetary and Fiscal Policies (February 2007). IMF Working Paper No. 07/30, Available at SSRN: https://ssrn.com/abstract=964338

S. Pelin Berkmen (Contact Author)

International Monetary Fund (IMF) ( email )

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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
76
Abstract Views
840
rank
427,786
PlumX Metrics