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Price Stability and Debt Stability: A Wicksell-Lerner-Tinbergen Framework for Macroeconomic Policy

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Functional Finance and Monetary Policy session at 12th International Conference

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Price Stability and Debt Stability: A Wicksell-Lerner-Tinbergen Framework for Macroeconomic Policy

  1. 1. Price Stability and Debt Stability Price Stability and Debt Stability: A Wicksell-Lerner-Tinbergen Framework for Macroeconomic Policy J. W. Mason and Arjun Jayadev September 25, 2014
  2. 2. Price Stability and Debt Stability Introduction I Debate: Is ability to reach full employment through
  3. 3. scal de
  4. 4. cits constrained by public debt sustainability? I Debate about de
  5. 5. nition of sustainability. I One useful de
  6. 6. nition of sustainable debt: stable debt-GDP ratio I Question: Does expansionary
  7. 7. scal policy imply rising debt-GDP ratio? I Answer: No. (Sometimes requires debt-GDP ratio to converge to higher, but
  8. 8. nite, level). I Why? Interest rate and de
  9. 9. cits aect debt trajectory
  10. 10. Price Stability and Debt Stability Our Framework I Wicksellian natural interest rate (zero output gap) and sustainable budget balance (constant debt-GDP ratio) are jointly determined. I Medium-run analysis: Given average level of private demand, in ation and growth over a business cycle or decade, what combinations of interest rate and budget balance are consistent with each goal? I Simplest solution: Coordination of monetary and
  11. 11. scal policy to achieve both. I But political and practical arguments for distinct portfolios, or for central bank independence
  12. 12. Price Stability and Debt Stability Dynamics of Policy Adjustment I Tinbergen issue: we have two instruments (interest rate and budget balance) and two targets (constant debt ratio and full employment/price stability). I Sound
  13. 13. nance rule assigns interest rate to output gap and budget balance to debt-GDP ratio. Functional
  14. 14. nance rule has opposite assignment. I In principle, assignment makes no dierence. Both imply identical equilibrium values for interest rate and budget balance. I Sound
  15. 15. nance and functional
  16. 16. nance appear radically dierent but do not generally imply dierent policy outcomes I But in practice, wrong assignment can amplify shocks, creating endogenous policy cycles or divergence
  17. 17. Price Stability and Debt Stability Policy Goals: Price Stability or Full Employment Standard assumptions of textbook 3-equation macroeconomic models, shared by all practical forecasters: I There is a well-de
  18. 18. ned level of potential output I Goal of macro policy: minimize output gap I Keeping output at potential encompasses goals of both price stability and full employment I Current output is a negative function of the interest rate and a positive function of government de
  19. 19. cits I Private demand (including the trade balance) varies over time
  20. 20. Price Stability and Debt Stability IS equation y = z

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