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Published online by Cambridge University Press:  20 July 2017

Cristiano Cantore
University of Surrey
Paul Levine*
University of Surrey
Giovanni Melina
International Monetary Fund and City University London
Joseph Pearlman
City University London
Address correspondence to: Paul Levine, School of Economics, University of Surrey, Guildford GU2 7XH, UK; e-mail:


The initial government debt-to-gross domestic product (GDP) ratio and the government's commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GDP ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary–fiscal rules with passive fiscal policy, designed for an environment with “normal shocks,” perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds—under commitment—the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long- and short-term bonds.

Copyright © Cambridge University Press 2017 

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Previous versions of this paper, circulated under the title “Optimal Fiscal and Monetary Rules in Normal and Abnormal Times,” were presented at seminars at the BI Norwegian Business School, the Universities of Loughborough, Oxford Manchester and Reading; at a European Monetary Forum Conference held at the Bank of Greece, “Financial Crisis – Models and Policy Responses,” Athens, 30–31 March 2012; at the conference “Monetary and Fiscal Policy Rules with Labour Market and Financial Frictions,” University of Surrey, 14–15 September 2012; the 6th International Conference on “Computational and Financial Econometrics” (CFE 2012), Oviedo, Spain, 1–3 December 2012; and the Barcelona Summer Forum “Fiscal Sustainability XXI Century,” Barcelona, Spain 9–10 June 2016. Comments by participants at these events are gratefully acknowledged, especially those of a discussant, Katsuyuki Shibayama, at the Surrey Conference and two anonymous referees for their comments and suggestions. All the remaining errors are ours. We also acknowledge financial support from ESRC project RES-062-23-2451. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or of the IMF board.


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