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The Effectiveness of Government Debt for Demand Management: Sensitivity to Monetary Policy Rules

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JournalJournal of Economic Dynamics and Control
DateE-pub ahead of print - 21 Feb 2013
DatePublished (current) - 2013
Issue number8
Volume37
Pages (from-to)1544-1566
Early online date21/02/13
Original languageEnglish

Abstract

We construct a staggered-price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make an increase in government debt, with associated changes in lump-sum taxation, effective in raising short-run output. However we find this is very sensitive to the monetary policy rule. A permanent increase in debt under a basic Taylor Rule does not raise output. To make debt effective we need either a temporary nominal interest rate peg; or inertia in the rule; or an exogenous money supply policy; or to make the debt increase temporary.

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