Fiscal Dominance and the Long-Term Interest Rate: FINANCIAL MARKETS GROUP SPECIAL PAPER SERIES

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Fiscal Dominance and the Long-Term Interest Rate: FINANCIAL MARKETS GROUP SPECIAL PAPER SERIES

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The question is how to translate the theoretical arguments of Keynes and Tirole into a policy that influences (but not rigidly determine) the long-term interest rate. Keynes’s prescription was that the government should gear its issuance policy to defining an upward-sloping floor for the risk-free yield curve. As will be noted below, the specific proposal of Keynes in 1945 was for a tap issue of both 5-year and 10-year bonds at fixed rates. How to do this in present-day terms? To provide the required insulation from inflation shocks, inflation-linked debt would be best. In normal circumstances, the market rate...

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