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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Paper provided by International Monetary Fund in its series IMF Working Papers with number
05/57.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1996.
"Law and Finance,"
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[Downloadable!] (restricted)
Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003.
"Debt Intolerance,"
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[Downloadable!]
Other versions:
Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003.
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