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Government Debt: A Key Role in Financial Intermediation

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  • Michael Kumhof
  • Evan Tanner

Abstract

The literature on optimal fiscal policy finds that highly volatile real returns on government debt, for example through surprise inflation, have very low costs. However, policymakers are almost always very apprehensive of this option. The paper discusses evidence concerning features of developing country financial markets that are missing in existing models, and that may suggest why this policy is considered so costly in practice. Most importantly, domestic banks choose to be highly exposed to government debt because the alternative, private lending, is more risky under existing legal and institutional imperfections. This exposure makes banks and their borrowers vulnerable to the government's debt policy.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/57.

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Length: 32
Date of creation: 01 Mar 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/57

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Keywords: Public debt;

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References

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  1. Richard J. Herring & Nathporn Chatusripitak, 2000. "The Case of the Missing Market: The Bond Market and Why It Matters for Financial Development," Center for Financial Institutions Working Papers 01-08, Wharton School Center for Financial Institutions, University of Pennsylvania.
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  7. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 531-554, April.
  8. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
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  11. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1105-1131, August.
  12. Vincent Reinhart & Brian Sack, 2000. "The Economic Consequences of Disappearing Government Debt," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 163-220.
  13. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
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