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Fiscal implications of interest rate normalization in the United States
Author(s) -
Bi Huixin,
Shen Wenyi,
Yang ShuChun S.
Publication year - 2022
Publication title -
canadian journal of economics/revue canadienne d'économique
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.773
H-Index - 69
eISSN - 1540-5982
pISSN - 0008-4085
DOI - 10.1111/caje.12584
Subject(s) - economics , zero lower bound , interest rate , monetary economics , government debt , debt , recession , bond , monetary policy , fiscal policy , fiscal sustainability , macroeconomics , finance
Abstract We study the fiscal implications of interest rate normalization from the zero lower bound (ZLB) in the United States. At the ZLB, falling tax revenues and real bond prices increase government debt accumulation. During normalization, interest payments remain above the path without the ZLB, and government debt can increase further despite the recovery of output and tax revenues. Against the yardstick of ability to pay, interest rate normalization is unlikely to threaten federal debt sustainability at the current net federal debt level about 100% of GDP. If the government fails to reform Social Security and major healthcare programs, sovereign default risk can rise more quickly when debt reaches 150% of GDP. Also, a more active monetary policy anchors inflation expectations better, generates a faster recovery and, hence, slows down debt accumulation more than a less active one does. An unexpected early liftoff, however, can prolong a recession and increase debt accumulation more at the ZLB and during normalization.