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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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Bibliographic Info

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. 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.
  2. 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.
  3. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
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  6. Reis, Catarina, 2006. "Taxation without Commitment," MPRA Paper 2071, University Library of Munich, Germany.
  7. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  8. Martin Ellison & Neil Rankin, 2005. " Optimal Monetary Policy When Lump-Sum Taxes Are Unavailable: A Reconsideration of the Outcomes under Commitment and Discretion," CDMA Conference Paper Series 0501, Centre for Dynamic Macroeconomic Analysis.
  9. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-39, August.
  10. 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.
  11. Ramon Marimon & Juan Pablo Nicolini & Pedro Teles, 2003. "Inside-outside money competition," Working Paper Series WP-03-09, Federal Reserve Bank of Chicago.
  12. 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.
  13. Svensson, Lars E O, 1985. "Money and Asset Prices in a Cash-in-Advance Economy," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 919-44, October.
  14. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  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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