Can Monetary Policy Create Fiscal Capacity?

72 Pages Posted: 9 Aug 2021 Last revised: 30 Aug 2021

See all articles by Vadim Elenev

Vadim Elenev

Johns Hopkins Carey Business School

Tim Landvoigt

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Patrick Shultz

University of Pennsylvania - Finance Department

Stijn Van Nieuwerburgh

Columbia University Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); ABFER

Multiple version iconThere are 3 versions of this paper

Date Written: August 2021

Abstract

Governments around the world have gone on a massive fiscal expansion in response to the Covid crisis, increasing government debt to levels not seen in 75 years. How will this debt be repaid? What role do conventional and unconventional monetary policy play? We investigate debt sustainability in a New Keynesian model with an intermediary sector, realistic fiscal and monetary policy, endogenous convenience yields, and substantial risk premia. When conventional monetary policy is constrained by the ZLB during an economic crisis, increased government spending and lower tax revenue lead to a large rise in government debt and raise the risk of future tax increases. We find that quantitative easing (QE), forward guidance, and an expansion in government discretionary spending all contribute to lowering debt/GDP ratio and reducing this fiscal risk. A transitory QE policy deployed during a crisis stimulates aggregate demand.

Suggested Citation

Elenev, Vadim and Landvoigt, Tim and Shultz, Patrick and Van Nieuwerburgh, Stijn, Can Monetary Policy Create Fiscal Capacity? (August 2021). NBER Working Paper No. w29129, Available at SSRN: https://ssrn.com/abstract=3901593

Vadim Elenev (Contact Author)

Johns Hopkins Carey Business School ( email )

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Tim Landvoigt

University of Pennsylvania - The Wharton School ( email )

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Philadelphia, PA 19104-6365
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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Patrick Shultz

University of Pennsylvania - Finance Department ( email )

The Wharton School
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Stijn Van Nieuwerburgh

Columbia University Graduate School of Business ( email )

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HOME PAGE: http://https://www0.gsb.columbia.edu/faculty/svannieuwerburgh/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

London
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ABFER ( email )

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