Monetary Policy and Government Debt


We study how the level of government debt affects the effectiveness of monetary policy, i.e., the elasticity of economic aggregates to interest rate changes. We build a New Keynesian model where fiscal policy is non-Ricardian and government debt is risk-free. Wealth effects generated by government bonds weaken the transmission of changes in the policy rate to output. Using data on private ownership of public debt for the U.S., we find that when government debt is one standard deviation above its mean, the response of industrial production and unemployment to a monetary shock is reduced by 0.5pp and 0.075pp, respectively, out to a three-year horizon.

Accepted at Journal of Money, Credit, and Banking
Ethan Feilich
Ethan Feilich

Economist in the Office of Economic Policy at the U.S. Department of the Treasury