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Nominal Debt as a Burden on Monetary Policy

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  • Díaz-Giménez, Javier
  • Giovannetti, Giorgia
  • Marimon, Ramon
  • Teles, Pedro

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.

Suggested Citation

  • 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.
  • Handle: RePEc:cpr:ceprdp:6595
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    References listed on IDEAS

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    More about this item

    Keywords

    indexed debt; Markov-perfect equilibrium; nominal debt; optimal monetary policy; time consistency;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General

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