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Monetary Policy and Sovereign Debt Vulnerability

Author

Listed:
  • Carlos Thomas

    (Banco de España)

  • Galo Nuño

    (Banco de España)

Abstract

We investigate the trade-o¤s between price stability and sovereign debt sustainability, in a small-open-economy model where the government issues nominal debt without committing not to default or inflate. Inflation allows to absorb the e¤ect of aggregate shocks on the debt ratio, which improves sovereign debt sustainability. But the government incurs an ‘inflationary bias’: it creates (costly) inflation even when default is distant. For plausible calibrations, we find that abandoning the ability to inflate debt away raises welfare, even when the economy is close to default: the benefits from eliminating the inflationary bias dominate the costs from losing inflation’s debt-stabilizing role.

Suggested Citation

  • Carlos Thomas & Galo Nuño, 2016. "Monetary Policy and Sovereign Debt Vulnerability," 2016 Meeting Papers 329, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:329
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:macchp:v2-1697 is not listed on IDEAS
    2. Engler, Philipp & Große Steffen, Christoph, 2016. "Sovereign risk, interbank freezes, and aggregate fluctuations," European Economic Review, Elsevier, vol. 87(C), pages 34-61.
    3. Bolton, Patrick & Huang, Haizhou, 2017. "The Capital Structure of Nations," CEPR Discussion Papers 12157, C.E.P.R. Discussion Papers.
    4. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, Elsevier.
    5. repec:eee:inecon:v:110:y:2018:i:c:p:119-134 is not listed on IDEAS
    6. Ricardo Sabbadini, 2017. "Overcoming the Original Sin: Gains from Local Currency External Debt," Working Papers, Department of Economics 2017_27, University of São Paulo (FEA-USP).

    More about this item

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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