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The “mystery of the printing press” monetary policy and self-fulfilling debt crises

Corsetti, Giancarlo and Dedola, Luca (2014) The “mystery of the printing press” monetary policy and self-fulfilling debt crises. CFM discussion paper series (CFM-DP2014-24.2). Centre For Macroeconomics, London, UK.

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Abstract

We study the mechanism by which unconventional (balance-sheet) monetary policy can rule out self-fulfilling sovereign default in a model with optimizing but discretionary fiscal and monetary policymakers. By purchasing sovereign debt, the central bank e§ectively swaps risky government paper for monetary liabilities only exposed to inflation risk, thus yielding a lower interest rate. We characterize a critical threshold for central bank purchases beyond which, absent fundamental fiscal stress, the government strictly prefers primary surplus adjustment to default. Since default may still occur for fundamental reasons, however, the central bank faces the risk of losses on sovereign debt holdings, which may generate ine¢cient inflation. This risk does not undermine the credibility of a backstop, nor the ability of a central bank to pursue its inflation objectives when the latter enjoys fiscal backing or fiscal authorities are su¢ciently averse to inflation.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information: © 2014 The Authors
Divisions: Centre for Macroeconomics
Subjects: H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Centre for Macroeconomics
Date Deposited: 15 Dec 2017 08:10
Last Modified: 02 Aug 2020 23:09
URI: http://eprints.lse.ac.uk/id/eprint/86333

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