Economics and Business Economics Seminar (ECO): Matthias Hänsel, Stockholm University

Abstract:

How does public debt matter for price stability? When the private sector holds it to insure against idiosyncratic risk, even temporarily higher government debt can exert upward pressure on interest rates and generate inflation. As I demonstrate analytically, the result holds under an active Taylor rule and does not require the absence of future fiscal consolidation. A quantitative 2-asset HANK model furthermore reveals that the magnitude of the inflation impact depends on the structure of the asset market: In order to match relevant evidence regarding the relationship between public debt and treasury returns, the markets for liquid and illiquid assets can neither be entirely segmented nor entirely integrated. The model suggests that in the US, public debt itself played a modest role in producing the inflation peak in 2022, but is crucial to inflation remaining elevated thereafter.