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Debt and incomplete financial markets: a case for nominal GDP targeting

  • Kevin D. Sheedy

Financial markets are incomplete, thus for many agents borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating agents' nominal incomes from aggregate real shocks, this policy effectively completes the market by stabilizing the ratio of debt to income. The paper argues that the objective of nominal GDP should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.

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File URL: http://eprints.lse.ac.uk/51545/
File Function: Open access version.
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Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 51545.

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Length: 102 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:ehl:lserod:51545
Contact details of provider: Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
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Web page: http://www.lse.ac.uk/

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  1. Carlos Garriga & Finn E. Kydland & Roman Šustek, 2013. "Mortgages and Monetary Policy," Discussion Papers 1306, Centre for Macroeconomics (CFM).
  2. Meade, James E, 1993. "The Meaning of "Internal Balance."," American Economic Review, American Economic Association, vol. 83(6), pages 3-9, December.
  3. Cochrane, John H, 1991. "A Simple Test of Consumption Insurance," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 957-76, October.
  4. Sheedy, Kevin D., 2014. "Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting," CEPR Discussion Papers 9843, C.E.P.R. Discussion Papers.
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