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Nominal Debt as a Burden on Monetary Policy

  • Javier Díaz-Giménez
  • Giorgia Giovanetti
  • Ramon Marimon
  • Pedro Teles

We study the effects of nominal debt on the optimal sequential choice of monetary policy. When the stock of debt is nominal, the incentive to generate unanticipated inflation increases the cost of the outstanding debt even if no unanticipated inflation episodes occur in equilibrium. Without full commitment, the optimal sequential policy is to deplete the outstanding stock of debt progressively until these extra costs disappear. Nominal debt is therefore a burden on monetary policy, not only because it must be serviced, but also because it creates a time inconsistency problem that distorts interest rates. The introduction of alternative forms of taxation may lessen this burden, if there is enough commitment to fiscal policy. Full commitment for the fiscal authority can override any commitment problem of the monetary authority.

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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 8.

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Date of creation: Sep 2015
Date of revision:
Handle: RePEc:bge:wpaper:8
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  1. Javier Días-Giménez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2006. "Nominal Debt as a Burden on Monetary Policy," Working Papers w200606, Banco de Portugal, Economics and Research Department.
  2. Fernando Alvarez & Patrick J. Kehoe & Pablo Andrés Neumeyer, 2004. "The Time Consistency of Optimal Monetary and Fiscal Policies," Econometrica, Econometric Society, vol. 72(2), pages 541-567, 03.
  3. Persson, Mats & Persson, Torsten & Svenssor, Lars E. O., 2005. "Time Consistency of Fiscal and Monetary Policy: A Solution," Papers 09-03-2005, Princeton University, Research Program in Political Economy.
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  6. 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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  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. 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.
  10. 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.
  11. 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.
  12. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  13. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  14. 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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