Is the Quantity of Government Debt a Constraint for Monetary Policy?

27 Pages Posted: 19 Mar 2007

See all articles by Srobona Mitra

Srobona Mitra

International Monetary Fund (IMF)

Date Written: March 2007

Abstract

This paper derives an interest rate rule for monetary policy in which the interest rate response of the central bank toward an increase in expected inflation falls as debts increase beyond a certain threshold level. A debt-constrained interest rate rule and the threshold level of debt are jointly estimated for Canada during the first decade of its inflation targeting regime of the 1990s. There are three main findings of this paper. First, a high government debt could constrain monetary policy if government spending - rather than taxes - is expected to adjust in future in line with debt service costs. The 'constraint' operates through an altered policy transmission mechanism through changes in the IS curve. Second, the effects of the debt-constraint on monetary policy are quite different during booms and recessions. Third, empirical estimates show that Canadian monetary policy might have been constrained by a high government debt-GDP ratio during the 1990s. Policy was less loose than what inflation indicators called for.

JEL Classification: E42, E52, E61

Suggested Citation

Mitra, Srobona, Is the Quantity of Government Debt a Constraint for Monetary Policy? (March 2007). IMF Working Papers, Vol. , pp. 1-25, 2007. Available at SSRN: https://ssrn.com/abstract=973992

Srobona Mitra (Contact Author)

International Monetary Fund (IMF) ( email )

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

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