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Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting

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  • Kevin D. Sheedy

    (London School of Economics)

Abstract

For many households borrowing is possible only by accepting a financial contract that specifies a fixed repayment stream. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper shows that when debt contracts are written in terms of money, a monetary policy of nominal GDP targeting improves the functioning of financial markets. By insulating households’ nominal incomes from aggregate real shocks, this policy effectively achieves risk sharing by stabilizing the ratio of debt to income. The paper also shows that when there is price stickiness, the objective of improving risk sharing should still receive considerable weight in the conduct of monetary policy relative to stabilizing inflation.
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Suggested Citation

  • Kevin D. Sheedy, 2014. "Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 45(1 (Spring), pages 301-373.
    • Handle: RePEc:bin:bpeajo:v:45:y:2014:i:2014-01:p:301-373
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    Keywords

    debt; financial markets; gdp; monetary policy; GDP targeting; debt; income; risk;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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