IMF Working Papers

Optimal Fiscal and Monetary Policy, Debt Crisis and Management

Author/Editor:

Cristiano Cantore ; Paul L Levine ; Giovanni Melina ; Joseph G Pearlman

Publication Date:

March 30, 2017

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Summary:

The initial government debt-to-GDP ratio and the government’s commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with “normal shocks”, perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds–under commitment–the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.

Series:

Working Paper No. 2017/078

Subject:

Asset and liability management Bonds Debt management Expenditure Financial institutions Fiscal policy Public debt