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Fiscal policy, public debt and central banks

This event is part of the virtual 20th Annual Conference webinars and panel discussions that were livestreamed on our website from 23 to 28 June. In his webinar, Professor Velasco presented "Joined at the hip: monetary and fiscal policy in a liquidity-driven world", a paper co-authored with Guillermo Calvo (Columbia University). In an environment of ultra-low interest rates, government bonds become money-like, and money becomes bond-like. But one key difference remains: the way their prices are set. Because money is the unit of account, the price of money is the inverse of the price level. If prices are sticky, so is the price of money in terms of goods. By contrast, the price of bonds is free to jump all over the place – and often does, even in the case of bonds as safe and liquid as US Treasuries. Mr Velasco and his co-authors explore the macroeconomic consequences of this asymmetry in an environment in which both money and bonds provide liquidity services. They find that certain fiscal policies (like an unanticipated and once-and-for-all helicopter drop of bonds) have no real effects. Others (for instance, an anticipated helicopter drop of bonds) cause a drop in bond prices, which in turn reduces liquidity, aggregate demand and output. These fiscal policies are expansionary if and only if they are complemented by monetary policies that stabilise liquidity provision. In that sense, monetary and fiscal policies are joined at the hip.