Seminar Why the Federal Reserve cuts rates when public debt rises Add to calendar 2026-02-02 11:00 2026-02-02 12:15 Europe/Rome Why the Federal Reserve cuts rates when public debt rises Conference Room Villa La Fonte YYYY-MM-DD Print Share: Share on Facebook Share on BlueSky Share on X Share on LinkedIn Send by email Scheduled dates Feb 02 2026 11:00 - 12:15 CET Conference Room, Villa La Fonte Organised by Department of Economics This event features a presentation by Andrea Ferrara (Northwestern University). We document a new fact: conditional on inflation and output, the Federal Reserve tends to lower its policy rate when the U.S. public debt-to-GDP ratio rises. To explain this pattern, we develop and estimate a New Keynesian model with shocks to households’ demand for public debt. These shocks generate a negative comovement between public debt and the natural rate of interest, defined as the real rate that would prevail in the flexible-price economy. Assuming that the Federal Reserve adjusts its policy rate in line with the natural rate, this mechanism rationalises the negative relationship between debt and the policy rate. We show that shocks to the demand for public debt are a key driver of business-cycle fluctuations and that policy rules responding to the natural rate reduce the volatility of inflation and output relative to standard rules. We further construct a debt-informed measure of the natural rate using a time-varying parameter vector autoregression model. Once this measure is included in the policy rule, an increase in the debt-to-GDP ratio no longer reduces the federal funds rate, consistent with the mechanism highlighted by the model. Register