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Government Debt

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Author Info

  • 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: 29
Date of creation: 01 Mar 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/57

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Keywords: Public debt; government debt; bond; financial institutions; bond markets; financial markets; bond market; government bond; bonds; domestic currency; financial intermediation; external debt; domestic debt; government bond market; private bond; government bond markets; financial market; derivatives markets; brady bonds; financial sector; reserve requirements; debt market; financial system; financial repression; debt management; financial sector development; debt stock; private credit; developing government bond markets; international financial statistics; developing government bond; debt policy; debt default; domestic financial system; government bonds; sovereign debt; deposit money banks; domestic financial systems; financial systems; asian bond market; private creditors; bond market development; currency debt; local bond markets; private sector bond; debt intolerance; international debt; private sector bond markets; market debt; deposit money; stock market; financial stability; currency board; state contingent bonds; domestic investors; debt portfolio; local bond; interest rate policy; reserve requirement; development of bond markets; international lending; money market; money market instruments; balance of payments; government bond market development; asset markets; financial reforms; public debt stock;

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References

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  1. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  2. Michael Kumhof, 2004. "Fiscal Crisis Resolution: Taxation Versus Inflation," 2004 Meeting Papers 874, Society for Economic Dynamics.
  3. 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.
  4. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
  5. Juan Pablo Nicolini & Francisco Buera, 2002. "Optimal Maturity of Governement Debt without state contingent bonds," Department of Economics Working Papers 016, Universidad Torcuato Di Tella.
  6. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  7. 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.
  8. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 1-74.
  9. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
  10. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
  11. repec:idb:brikps:34698 is not listed on IDEAS
  12. Guillermo A. Calvo & Carlos A. Végh, 1990. "Interest Rate Policy in a Small Open Economy: The Predetermined Exchange Rates Case," IMF Staff Papers, Palgrave Macmillan, vol. 37(4), pages 753-776, December.
  13. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
  14. Michael J. Flemming, 2000. "Financial Market Implications of the Federal Debt Paydown," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2), pages 221-252.
  15. World Bank & International Monetory Fund, 2001. "Developing Government Bond Markets : A Handbook," World Bank Publications, The World Bank, number 13865, October.
  16. Michael J. Fleming, 2001. "Financial market implications of the federal debt paydown," Staff Reports 120, Federal Reserve Bank of New York.
  17. 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.
  18. 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.
  19. 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.
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