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Nominal Debt as a Burden on Monetary Policy

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  • Javier Días-Giménez
  • Giorgia Giovannetti
  • Ramon Marimon
  • Pedro Teles

Abstract

We characterize the optimal sequential choice of monetary policy in economies with either nominal or indexed debt. In a model where nominal debt is the only source of time inconsistency, the Markov-perfect equilibrium policy implies the progressive depletion of the outstanding stock of debt, until the time inconsistency disappears. There is a resulting welfare loss if debt is nominal rather than indexed. We also analyze the case where monetary policy is time inconsistent even when debt is indexed. In this case, with nominal debt, the sequential optimal policy converges to a time-consistent steady state with positive - or negative - debt, depending on the value of the intertemporal elasticity of substitution. Welfare can be higher if debt is nominal rather than indexed and the level of debt is not too high.

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Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200606.

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Date of creation: 2006
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Handle: RePEc:ptu:wpaper:w200606

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  1. Obstfeld, Maurice, 1997. "Dynamic Seigniorage Theory," Macroeconomic Dynamics, Cambridge University Press, vol. 1(03), pages 588-614, September.
  2. Reis, Catarina, 2006. "Taxation without Commitment," MPRA Paper 2071, University Library of Munich, Germany.
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  4. Díaz-Giménez, Javier & Giovannetti, Giorgia & Marimon, Ramon & Teles, Pedro, 2007. "Nominal Debt as a Burden on Monetary Policy," CEPR Discussion Papers 6595, C.E.P.R. Discussion Papers.
  5. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
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  8. Ellison, Martin & Rankin, Neil, 2007. "Optimal monetary policy when lump-sum taxes are unavailable: A reconsideration of the outcomes under commitment and discretion," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 219-243, January.
  9. Chari, V.V. & Kehoe, Patrick J., 1999. "Optimal fiscal and monetary policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 26, pages 1671-1745 Elsevier.
  10. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Staff Report 147, Federal Reserve Bank of Minneapolis.
  11. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
  12. Juan Pablo Nicolini & Ramon Marimon & Pedro Teles, 2001. "Inside Outside Money Competition," Department of Economics Working Papers 004, Universidad Torcuato Di Tella.
  13. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
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  15. Juan P. Nicolini, 1993. "More on the time inconsistency of optimal monetary policy," Economics Working Papers 56, Department of Economics and Business, Universitat Pompeu Fabra.
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