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The Impact of Debt Levels and Debt Maturity on Inflation

Authors


  • Marcet is grateful for support from DGES, Monfispol and Excellence Programme of Banco de Espana. Faraglia and Scott gratefully acknowledge funding from the ESRC's World Economy and Finance Programme. Oikonomou is grateful to HEC Montreal for funding. Thanks to Giorgia Palladini for research assistance. Helpful feedback from Wouter den Haan and Pedro Teles is gratefully acknowledged.

Corresponding author: Rigas Oikonomou, HEC Montreal 2953, chemin de la Cote Sainte- Catherine, Montreal, QC H3T1C3, Canada. Email: rigas.oikonomou@hec.ca.

Abstract

We examine the implications for optimal inflation of changes in the level and maturity of government debt under the assumption where fiscal and monetary policies co-ordinate, and in the case of an independent central bank following a Taylor rule. Under co-ordination, inflation persistence and volatility depend on the sign, size and maturity of debt. Higher debt leads to higher inflation and longer maturity leads to more persistent inflation although inflation plays a minor role in achieving fiscal sustainability. Under an independent monetary authority, inflation is higher, more volatile and more persistent and plays a significant role in achieving fiscal solvency.

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