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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: Jan 2003
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Handle: RePEc:bge:wpaper:8
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  1. 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.
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  9. Persson , Mats & Persson , Torsten & Svensson, Lars E.O., 2004. "Time Consistency of Fiscal and Monetary Policy: A Solution," Seminar Papers 734, Stockholm University, Institute for International Economic Studies.
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  12. 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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