Discussion paper

DP11180 Dynamic Debt Deleveraging and Optimal Monetary Policy

This paper studies optimal monetary policy under dynamic debt
deleveraging once the zero bound is binding. Unlike much of the existing
literature, the natural rate of interest is endogenous and depends on
macroeconomic policy. We provide microfoundation for debt deleveraging based
both on household over accumulation of debt and leverage constraint on
banks; and show that they are isomorphic in our proposed post-crisis New
Keynesian model, thus integrating two popular narrative for the crisis.
Optimal monetary policy successfully raises the natural rate of interest by
creating an environment that speeds up deleveraging, thus endogenously
shortening the duration of the crisis and a binding zero bound. Inflation
should be front loaded. Fiscal-policy multipliers can be even higher than in
existing models, but depend on the way in which public spending is financed.

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Citation

Benigno, P, F Romei and G Eggertsson (2016), ‘DP11180 Dynamic Debt Deleveraging and Optimal Monetary Policy‘, CEPR Discussion Paper No. 11180. CEPR Press, Paris & London. https://cepr.org/publications/dp11180