Monetary Economics.

• Position: Bureau News - Panel Discussion

The NBER's Program on Monetary Economics met in Cambridge on April 16. Laurence M. Ball and Christopher D. Carroll, NBER and Johns Hopkins University, organized this program:

Thomas Laubach, Federal Reserve Board, "New Evidence on the Interest Rate Effects of Budget Deficits and Debt"

Discussant: Benjamin M. Friedman, NBER and Harvard University

Olivier J. Blanchard, NBER and MIT, "Fiscal Dominance and Inflation Targeting: Lessons from Brazil"

Discussant: Fredric S. Mishkin, NBER and Columbia University

Ricardo Reis, Harvard University, "Inattentive Consumers"

Discussant: John Shea, NBER and University of Maryland

Adam S. Posen, Institute for International Economics, "It Takes More than a Bubble to Become Japan"

Discussant: Takeo Hoshi, NBER and University of California, San Diego

Susanto Basu and Miles S. Kimball, NBER and University of Michigan, "Investment Planning Costs and the Effects of Fiscal and Monetary Policy"

Discussant: Simon Gilchrist, NBER and Boston University

Estimating the effects of government debt and deficits on Treasury yields is complicated by the need to isolate the effects of fiscal policy from other influences. In order to abstract from the effects of the business cycle and associated monetary policy actions on debt, deficits, and interest rates, Laubach studies the relationship between long-horizon expected government debt and deficits (measured by CBO and OMB projections) and expected future long-term interest rates. The estimated effects of government debt and deficits on interest rates are statistically and economically significant: a one percentage point increase in the projected deficit-to-GDP ratio is estimated to raise long-term interest rates by roughly 25 basis points. Under plausible assumptions these estimates are consistent with predictions of the neoclassical growth model.

A standard proposition in open-economy macroeconomics is that a central-bank-engineered increase in the real interest rate makes domestic government debt more attractive and leads to a real appreciation. However, if the increase in the real interest rate also increases the probability of default on the debt, then the effect instead may be to make domestic government debt less attractive, and to lead to a real depreciation. That outcome is more likely the higher the initial level of debt, the higher the proportion of foreign-currency-denominated debt, and the higher the price of risk. Under that outcome, inflation targeting clearly...