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Nominal debt as a burden on monetary policy

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

We study the effects of nominal debt on the optimal sequential choice of monetary policy. When the stock of debt is nominal, the incentive to generate unanticipated inflation increases the cost of the outstanding debt even if no unanticipated inflation episodes occur in equilibrium. Without full commitment, the optimal sequential policy is to deplete the outstanding stock of debt progressively until these extra costs disappear. Nominal debt is therefore a burden on monetary policy, not only because it must be serviced, but also because it creates a time inconsistency problem that distorts interest rates. The introduction of alternative forms of taxation may lessen this burden, if there is enough commtiment to fiscal policy. If there is full commitment to an optimal fiscal policy, then the resulting monetary policy is the Friedman rule of zero nominal interest rates.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 841.

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Date of creation: Jan 2003
Date of revision: Jan 2006
Handle: RePEc:upf:upfgen:841
Contact details of provider: Web page: http://www.econ.upf.edu/

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  1. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  2. Javier Díaz-Giménez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2004. "Nominal debt as a burden on monetary policy," Working Paper Series WP-04-10, Federal Reserve Bank of Chicago.
  3. Fernando Alvarez & Patrick J. Kehoe & Pablo Andrés Neumeyer, 2004. "The Time Consistency of Optimal Monetary and Fiscal Policies," Econometrica, Econometric Society, vol. 72(2), pages 541-567, 03.
  4. Mats Persson & Torsten Persson & Lars E. O. Svensson, 2006. "Time Consistency of Fiscal and Monetary Policy: A Solution," Econometrica, Econometric Society, vol. 74(1), pages 193-212, 01.
  5. Reis, Catarina, 2006. "Taxation without Commitment," MPRA Paper 2071, University Library of Munich, Germany.
  6. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
  7. 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.
  8. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  9. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  10. Obstfeld, Maurice, 1997. "Dynamic Seigniorage Theory," Macroeconomic Dynamics, Cambridge University Press, vol. 1(03), pages 588-614, September.
  11. Marimon, Ramon & Nicolini, Juan Pablo & Teles, Pedro, 2003. "Inside-Outside Money Competition," CEPR Discussion Papers 4039, C.E.P.R. Discussion Papers.
  12. Martin Ellison & Neil Rankin, 2005. " Optimal Monetary Policy When Lump-Sum Taxes Are Unavailable: A Reconsideration of the Outcomes under Commitment and Discretion," CDMA Conference Paper Series 0501, Centre for Dynamic Macroeconomic Analysis.
  13. 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.
  14. 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.
  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.
  16. 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.
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