## Fiscal Implications of Interest Rate Normalization in the United States

_IMF Working Papers, May 3, 2019_

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## Bibliographic details
- Authors: Huixin Bi, Wenyi Shen, Shu-Chun Susan Yang
- Published: May 3, 2019
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498311151.001

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### Main channels and mechanisms
- Unexpected inflation reduces the real value of government liabilities.
- A rising policy rate increases government financing needs through:
  - higher interest payments, and
  - lower real bond prices.
- Interaction of these forces produces a non-monotonic path for the real government debt burden:
  - an initial decline in the real debt burden, followed by a rise even when tax revenues increase during an expansion.

### Key findings
- Given the current net debt-to-GDP ratio at around 80 percent, interest rate normalization leads to a negligible increase in the sovereign default risk of the U.S. federal government.
- This negligible increase in default risk occurs despite a much higher federal debt-to-GDP ratio than the post-war historical average.

### Model and analytical focus
- The analysis emphasizes monetary and fiscal policy interaction using New Keynesian and non linear DSGE models.
- Technical constructs and keywords highlighted in the study include:
  - devaluation effect, equilibrium debt valuation equation, fiscal sustainability,
  - Capital income tax, income tax, interest payments, interest rate normalization,
  - liabilities decline and debt level dynamics.

### Implications for policy
- Policymakers should consider that:
  - Inflation episodes can mechanically reduce real liabilities, but
  - normalization of the policy rate raises financing needs via higher interest payments and depressed bond prices, which can reverse initial improvements in the real debt burden.
- Fiscal planning should account for the dynamic, potentially delayed, increase in the real debt burden following interest rate normalization, even in periods of rising tax revenues.

*Source: Fiscal Implications of Interest Rate Normalization in the United States (IMF Working Paper).*

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_Source: https://www.imf.org/en/publications/wp/issues/2022/06/06/fiscal-implications-of-interest-rate-normalization-in-the-united-states-46820_