3.1 Introduction

On average public debt in the advanced economies has exceeded 100% of GDP in 2012, levels that are unprecedented in peace time. The rise in government debt raises concerns about the sustainability of public finances and the implications for growth and inflation. For example, taking into account the large and rising fiscal costs related to an ageing population, Cecchetti et al. (2010) conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Reinhart and Rogoff (2010), Cecchetti et al. (2011) and Baum et al. (2013) have documented that historically public debt ratios of more than 80–90% typically are associated with a long subsequent period of low growth. Smets and Trabandt (2012) review the implications of rising government debt for inflation and monetary policy. First, they argue that high government debt constrains an active use of fiscal policy (as was for example the case within the euro area for Belgium and Italy going into the financial crisis of 2008) and therefore puts a larger burden on monetary policy to stabilise the economy. This may not be straight-forward if standard monetary policy is constrained by the zero lower bound on nominal short-term interest rates. Second, to the extent that long-term government debt is issued in nominal terms it increases the pressure to reduce the real value of the debt by unexpected inflation. High government debt may also increase the pressure to rely on alternative sources of government finance such as central bank seignorage.