tailieunhanh - Fiscal Dominance and the Long-Term Interest Rate: FINANCIAL MARKETS GROUP SPECIAL PAPER SERIES

The question is how to translate the theoretical arguments of Keynes and Tirole into a policy that influences (but not rigidly determine) the long-term interest rate. Keynes’s prescription was that the government should gear its issuance policy to defining an upward-sloping floor for the risk-free yield curve. As will be noted below, the specific proposal of Keynes in 1945 was for a tap issue of both 5-year and 10-year bonds at fixed rates. How to do this in present-day terms? To provide the required insulation from inflation shocks, inflation-linked debt would be best. In normal circumstances, the market rate. | ISSN 1359-9151-199 Fiscal Dominance and the Long-Term Interest Rate By Philip Turner SPECIAL PAPER 199 FINANCIAL MARKETS GROUP SPECIAL PAPER SERIES May 2011 Philip Turner has been at the BIS in Basel since 1989 where he is Deputy Head of the Monetary and Economic Department. He is responsible for economics papers produced for central bank meetings at the BIS. Between 1976 and 1989 he held various positions including head of division in the Economics Department at the OECD in Paris. In 198586 he was a visiting scholar at the Bank of Japan s Institute for Monetary and Economic Studies in Tokyo. He read Economics at Churchill College Cambridge and has a PhD from Harvard University. Any opinions expressed here are those of the author and not necessarily those of the FMG. The research findings reported in this paper are the result of the independent research of the author and do not necessarily reflect the views of the LSE. 19 April 2011 FISCAL DOMINANCE AND THE LONG-TERM INTEREST RATE Philip Turner Abstract Very high government debt GDP ratios will increase uncertainty about inflation and the future path of real interest rates. This will reduce substitutability across the yield curve. In such circumstances changes in the short-term long-term mix of government debt held by the public will become more effective in achieving macroeconomic objectives. In circumstances of imperfect substitutability central bank purchases or sales of government bonds have been seen historically as a key tool of monetary policy. Since the mid-1990s however responsibility for government debt management has been assigned to other bodies. The mandates of the government debt manager could have the unintended consequence of making their actions endogenous to macroeconomic policies. There is evidence that decisions on the maturity of debt have in the past been linked to both fiscal and monetary policy. Recent Quantitative Easing QE by the central bank must be analysed from the perspective of the .