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Nominal Debt as a Burden on Monetary Policy

  • Javier Diaz-Gimenez
  • Giorgia Giovannetti
  • Ramon Marimon
  • Pedro Teles

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.

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Paper provided by European University Institute in its series Economics Working Papers with number ECO2007/53.

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Date of creation: 2007
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Handle: RePEc:eui:euiwps:eco2007/53
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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.
  2. 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.
  3. Fernando Martin, 2009. "A Positive Theory of Government Debt," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(4), pages 608-631, October.
  4. Persson, Mats & Persson, Torsten & Svensson, Lars E O, 2005. "Time Consistency of Fiscal and Monetary Policy: A Solution," CEPR Discussion Papers 4941, C.E.P.R. Discussion Papers.
  5. Ramon Marimon & Javier Díaz-Giménez & Giorgia Giovannetti & Pedro Teles, 2007. "Nominal Debt as a Burden on Monetary Policy," NBER Working Papers 13677, National Bureau of Economic Research, Inc.
  6. 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.
  7. Ramon Marimon & Juan Pablo Nicolini & Pedro Teles, 2003. "Inside-outside money competition," Working Paper Series WP-03-09, Federal Reserve Bank of Chicago.
  8. Obstfeld, Maurice, 1997. "Dynamic Seigniorage Theory," Macroeconomic Dynamics, Cambridge University Press, vol. 1(03), pages 588-614, September.
  9. Catarina Reis, 2013. "Taxation without commitment," Economic Theory, Springer, vol. 52(2), pages 565-588, March.
  10. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
  11. 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.
  12. 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.
  13. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report 251, Federal Reserve Bank of Minneapolis.
  14. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  15. 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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