Economics Seminar - Luisa Lambertini

We study the impact of different fiscal and monetary strategies on debt stability in the wake of a large increase in debt. We propose a macroeconomic policy under which debt stability is achieved by a Quantitative Easing (QE) rule that responds to changes in the government debt-to-GDP ratio. In a New Keynesian DSGE model with household heterogeneity, financial frictions, and nominal rigidities calibrated to the U.S. economy, we show that the QE profits earned from the bond-reserve spread and remitted to the treasury are a significant source of fiscal revenues. We compare the use of QE to changes in taxes as a debt stabilization tool under both an active and passive monetary policy framework. We find that the QE rule can stabilize debt even without an increase in taxes and that its general equilibrium effects are less contractionary.