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Nominal versus indexed debt: A quantitative horse race

  • Alfaro, Laura
  • Kanczuk, Fabio

The main arguments in favor and against nominal and indexed debts are the incentive to default through inflation versus hedging against unforeseen shocks. We model and calibrate these arguments to assess their quantitative importance. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and contingent-debt service. Our framework also recognizes that contingent debt can be associated with incentive problems and lack of commitment. Thus, the benefits of unexpected inflation are tempered by higher interest rates. We obtain that costs from inflation more than offset the benefits from reducing tax distortions. We further discuss sustainability of nominal debt in developing (volatile) countries.

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Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 29 (2010)
Issue (Month): 8 (December)
Pages: 1706-1726

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Handle: RePEc:eee:jimfin:v:29:y:2010:i:8:p:1706-1726
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

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