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Nominal versus Indexed Debt: A Quantitative Horse Race

  • Laura Alfaro
  • Fabio Kanczuk

The main arguments in favor and against nominal and indexed debt are the incentive to default through inflation versus hedging against unforeseen shocks. We model and calibrate these arguments to assess their quantitative importance. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and contingent-debt service. Our framework also recognizes that contingent debt can be associated with incentive problems and lack of commitment. Thus, the benefits of unexpected inflation are tempered by higher interest rates. We obtain that costs from inflation more than offset the benefits from reducing tax distortions. We further discuss sustainability of nominal debt in developing (volatile) countries.

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File URL: http://www.nber.org/papers/w13131.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13131.

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Date of creation: May 2007
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Publication status: published as Alfaro, Laura & Kanczuk, Fabio, 2010. "Nominal versus indexed debt: A quantitative horse race," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1706-1726, December.
Handle: RePEc:nbr:nberwo:13131
Note: IFM ME PE
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