Conducting Monetary Policy with Large Public Debts · Conducting Monetary Policy with Large Public...
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Conducting Monetary Policy with Large Public Debts
Gita Gopinath Harvard University
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Large Public Debts
Net Government debt to GDP
Greece 155
Japan 134
Portugal 111
Italy 103
Ireland 102
United States 87
France 84
United Kingdom 82
Spain 71
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Large Public Debts
Net Government debt to GDP
Greece 155
Japan 134
Portugal 111
Italy 103
Ireland 102
United States 87
France 84
United Kingdom 82
Spain 71
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Self-fulfilling Crises
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Self-fulfilling Crises
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1. Does ability to inflate reduce exposure to roll-over crises?
2. Should monetary policy play an active role in debt crises?
3. How much of inflation commitment is optimal?
Questions
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Aguiar, Amador, Farhi and Gopinath (2014)
Crisis and Commitment: Inflation Credibility and the Vulnerability to Self-fulfilling debt crisis
Coordination and Crises in a Monetary Union
Papers
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Monetary Policy
Fiscal Policy
Monetary Policy
Fiscal Policy
Case 2: MUCase 1: SOE
Monetary Policy
Fiscal Policy
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Government issues nominal bonds
Lenders expect real risk free rate
compensated for expected inflation and default risk.
Environment (SOE)
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1. Preferences
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2. Budget Constraint
Environment
Z 1
0e�r⇤t (u(ct)� 0⇡t) dt
ct = y + bt � (rt � ⇡t) bt
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Environment
Low Temptation
Foreign currency debt: ! 1
Government lacks commitment to inflation: Cost
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0
High Temptation
1
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Government lacks commitment to repay
-Cost is exclusion from financial markets
Environment
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Roll-over Risk
Coordination failure among lenders
For high values of debt
if each lender thinks all other lenders will roll-over: no crises
if each lender thinks all other lenders will not roll-over: then debt run
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Constructing Debt RunsSuppose the government cannot roll over
To avoid default, needs to repay
generate fiscal surpluses
use inflation
If the value of repayment is below the default value
roll-over crisis is self-fulfilling: vulnerable to crisis
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Debt Threshold
How does the vulnerability debt cut-off depend on the ability to inflate ?
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Debt ThresholdCrisis Region as a function of
b�
0
Debt
Vulnerable
Safe
33 / 35
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Crisis Region as a function of
b�
0
Debt
Vulnerable
Safe
Two extremes cases: = 0 = 1andIn the first: inflate all the timeIn the second: never inflateSame vulnerability: inflation is not state contingent
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Debt Threshold
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Crisis Region as a function of
b�
0
Debt
Vulnerable
Safe
More generally two opposite effects when increases
Increases the cost of repayingin case of a run
It may reduce equilibrium inflation Reduces equilibrium interest rate
Reduces the cost of repaying in case of a run
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Debt Threshold
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Crisis Region as a function of
0
Debt
Safe
More generally two opposite effects when increases
Increases the cost of repayingin case of a run
Vulnerableb�
It may reduce equilibrium inflation Reduces equilibrium interest rate
Reduces the cost of repaying in case of a run
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Debt Threshold
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Crisis Region as a function of
0
Debt
Safe
More generally two opposite effects when increases
Increases the cost of repayingin case of a run
Vulnerableb�
It may reduce equilibrium inflation Reduces equilibrium interest rate
Reduces the cost of repaying in case of a run
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Debt Threshold
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1. Fiscal Externality
2. Heterogenous Debt Levels
Monetary Union
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Heterogeneity in Public Debts in Euro Area
Net Government debt to GDP
Greece 155
Portugal 111
Italy 103
Ireland 102
France 84
Spain 71
Germany 57
Netherlands 32
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Fiscal Externality
Countries do not internalize the impact of their debt decisions on borrowing costs
Too much debt
Not save enough
Too high inflation
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Heterogenous Debt Levels
Incentive to inflate depends on the fraction of high debtors in the union.
Roll-over risk makes joining a union with low debtors costly for high debt countries.
Monetary intervention “off-equilibrium” promise, so low-debtors do not have to necessarily loose.
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Does ability to inflate reduce exposure to roll-over crises?
Should monetary policy play an active role in debt crises?
How much of inflation commitment is optimal?
Take Aways
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Not necessarily
Yes
Intermediate