Southwestern University of Finance and Economics
School of Economics
555, Liutai Avenue
Institutional Affiliation: Southwestern University of Finance and Economics
NBER Working Papers and Publications
|March 2019||Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy|
with Eric M. Leeper, Campbell B. Leith: w25658
The textbook optimal policy response to an increase in government debt is simple—monetary policy should actively target inflation, and fiscal policy should smooth taxes while ensuring debt sustainability. Such policy prescriptions presuppose an ability to commit. Without that ability, the temptation to use inflation surprises to offset monopoly and tax distortions, as well as to reduce the real value of government debt, creates a state-dependent inflationary bias problem. High debt levels and short-term debt exacerbate the inflation bias. But this produces a debt stabilization bias because the policy maker wishes to deviate from the tax smoothing policies typically pursued under commitment, by returning government debt to steady-state. As a result, the response to shocks in New Keynesian ...