Is High Debt Constraining Monetary Policy? Evidence from Inflation Expectations

IMF Working Papers, June 30, 2023

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Canonical URL: Is High Debt Constraining Monetary Policy? Evidence from Inflation Expectations

Authors: Luis Brandao Marques, Marco Casiraghi, Gaston Gelos, Olamide Harrison, Güneş Kamber
Published: June 30, 2023
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9798400243059.001

Authors: Luis Brandão-Marques, Marco Casiraghi, Gaston Gelos, Olamide Harrison, Güneş Kamber
Publication date: June 30, 2023
Series: Working Paper No. 2023/143
Volume: 2023; Issue: 143; Pages: 33
DOI: https://doi.org/10.5089/9798400243059.001
Stock No: WPIEA2023143
ISBN: 9798400243059
ISSN: 1018-5941
Subject keywords: debt, debt dollarization, debt surprise, Emerging and frontier financial markets, fiscal dominance, Fiscal stance, Foreign currency debt, Global, government debt shock, Inflation, inflation expectation, Inflation expectations, monetary policy, share classification, Western Hemisphere

Examines whether high government debt levels pose a challenge to containing inflation.
Assesses the impact of government debt surprises on inflation expectations in advanced- and emerging market economies.

Debt surprises raise long-term inflation expectations in emerging market economies in a persistent way, but not in advanced economies.
The effects of debt surprises are stronger when:
- initial debt levels are already high;
- inflation levels are initially high;
- debt dollarization is significant.
By contrast, debt surprises have only modest effects in economies with inflation targeting regimes.
Increased debt levels may complicate the fight against inflation in emerging market economies with high and dollarized debt levels, and weaker monetary policy frameworks.

Monitor and manage government debt levels, particularly in emerging market economies where:
- high initial debt amplifies the effect of debt surprises on long-term inflation expectations;
- significant debt dollarization increases vulnerability.
Strengthen monetary policy frameworks (for example, inflation targeting regimes) to mitigate the pass-through from debt surprises to inflation expectations.
Consider fiscal policy and debt structure reforms that reduce dollarization and lower the risk that debt dynamics will interfere with disinflation efforts.

The interaction between debt surprises and inflation expectations differs across country groups: persistent upward effects in emerging market economies, but not in advanced economies.
The combination of high debt, high inflation, significant debt dollarization, and weaker monetary policy frameworks can complicate efforts to contain inflation in emerging market economies.

IMF Working Paper No. 2023/143 (June 30, 2023) — Luis Brandão-Marques; Marco Casiraghi; Gaston Gelos; Olamide Harrison; Güneş Kamber.