Does Government Debt Weaken Monetary Policy Transmission?

This paper studies whether the effectiveness of monetary policy depends on government debt. Using a panel of Euro Area countries, I find that the effect of a one-standard-deviation monetary policy shock on real activity is dampened by 0.012 percentage points at its peak for each 1-percentage-point increase in the debt-to-GDP ratio. This implies that a one-standard-deviation increase in government debt reduces the cumulative GDP growth response to the shock by 0.42 percentage points. These results suggest that a sound fiscal position is crucial for the effective transmission of monetary policy.