229-08-L13

229-08-L13 - Notes on Fiscal Reaction Functions Graphical...

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Notes on Fiscal Reaction Functions • Graphical Illustrations in Bohn (QJE 1998): Surplus vs. Debt, 1917-1995
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• Deterministic intuition: Debts accumulate from deficits. => Sustainable policy means running sufficient surpluses. • Uncertain world: Dynamics of debt depends on how the debt is managed. - Traditional: Bonds—nominal, inflation-linked, foreign-currency, short/long. - Worth considering: Securities with hedging features: GDP-indexed, etc. => Sustainability is conditional on debt management. [Also conditional on monetary policy—set aside here—take seignorage as given] Conceptual question #1: Does “Fiscal Policy” include debt management? - If not : Sustainable policies must respond to disturbances. - If yes : Space of sustainable policies is much enlarged.
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• Policy tools = Taxes and spending. Sustainability requires ‘robustness’: Are there conditions on primary surpluses that ensure sustainability regardless of debt management ? • Key insight: Sustainability requires responsiveness to shocks. • Thought experiment: - Start with a sustainable path of primary surpluses. - Suppose disturbance hits – debt increases slightly. Without response, debt will remain above previous path, grow exponentially. [One exception—later] - Examples: Decline in revenues. Unexpected spending needs. Bad realization of contingent liabilities. • Finding
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229-08-L13 - Notes on Fiscal Reaction Functions Graphical...

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