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Policy impact on capital market expectations

Hello,

Need clarification about what inflating away the real value of debt by  an accommodative monetary policy means. The situation is that fiscal deficit is high as consequence of government spending. So the amount of debt the government owes is high.

Does it mean that instead of pulling interest rates up (as it would be the case in an high inflation scenario) the central bank may instead be forced by the government to let the interest rates loose so the inflation stays high or even increases making the value (cost) of the debt less significative in real terms?

Thanks,

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It means dump bonds. 

¯\_(ツ)_/¯ It be like that sometimes.

Hi “CEO 10k-day”, thanks for your reply but could you be more precise? Another question, about VIX index this time. Why is that if VIX futures curve is in contango, rolling down the curve generates losses? If the roll is calculated as front month’s future price - current future price divided by days remaining to expiration, that calculation will be always positive, at a decreasing rate as the current futures price will converge to the spot price but still positive. Thanks

Please disregard the second doubt about the VIX index. I was just not considering what rolling down the curve implies (ie selling current contract at a lower price and buying the forthcoming month’s at a higher price = loss)

Josep wrote:

Need clarification about what inflating away the real value of debt by  an accommodative monetary policy means. The situation is that fiscal deficit is high as consequence of government spending. So the amount of debt the government owes is high.

Most countries nowadays separate government funding from central bank policies (tight vs loose monetary policies), so it is uncommon to inflating away government debt by creating an artificial inflationary scenario. Nevertheless, we can explain the mechanism.

The artificial inflationary scenario is created by a higher issuance of money (by the central bank) with the sole purpose of decrease purchase value of money. When higher quantities of money than required are issued, inflation takes place rapidly, therefore, the current government debt becomes cheaper in real terms (easier to repay).

Josep wrote:

Does it mean that instead of pulling interest rates up (as it would be the case in an high inflation scenario) the central bank may instead be forced by the government to let the interest rates loose so the inflation stays high or even increases making the value (cost) of the debt less significative in real terms?

Your reasoning is good, but be careful with the timing. As I said above, the intention of deflating debt (make it cheaper for the gov) is to first create an artificial inflation scenario. This is created using a loose monetary policy by the central bank (note that the central bank must lack independence from gov to this be true). Central bank will never increase the rates as it should be to counter inflation because the objective is to deflate government debt. Foolish.

This is why central banks MUST and ARE independent from government policies. Also, this is why it is important to understand monetary policies vs fiscal policies because they are independent from each other in most countries and are not always coordinated, so they can cancel each other out, potentiate each other, or lead to an uncertain outcome.

Las almas de todos los hombres son inmortales, pero las almas de los justos son inmortales y divinas.
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Thanks very much! very clear now