“Debt-Deflation” Risk and Monetary-Fiscal Policy Interactions
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| Title | “Debt-Deflation” Risk and Monetary-Fiscal Policy Interactions
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| Author | Chen Xiaoliang and Ma Xiao |
| Organization | Institute of Economics, CASS; Department of Economics, University of California, San Diego |
| Email | chenxiaoliang2200@126.com；martinmx87@163.com |
| Key Words | Debt-deflation; Monetary Policy; Fiscal Policy; Policy Interaction; DSGE Model |
| Abstract | Confronted with the coexistence of heavy debt and deflation in economy, China shall take action to safeguard “debt-deflation” risk. Experience from US and Japan reveals that when solely used to stabilize aggregate demand during the period of “debt-deflation” cycles, fiscal or monetary policy has to be intense and could easily become unsustainable. By constructing a dynamic stochastic general equilibrium (DSGE) model involving novel features of heavy debt and deflation as well as the execution of fiscal and monetary policy that conforms to reality in China, this paper shows that monetary-fiscal interactions can ameliorate the sustainability of fiscal and monetary policy and improve the government’s ability to resolve “debt-deflation” cycles by creating new room for fiscal policy and reducing required intensity of monetary policy. On one hand, the “reflation” effect of monetary policy can cut down real debt and financing costs of the government, thus allowing for room of fiscal expansion. On the other hand, active fiscal policy will also exert the effect of “reflation” which in turn lower the magnitude of monetary policy needed to accomplish adequate “reflation”. Therefore, it is advisable for Chinese government to strengthen monetary-fiscal policy interactions to prevent the economy from being stuck in “debt-deflation” cycles. |
| Serial Number | WP1124 |
| Time | 2016-10-18 |
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