Nominal Debt as a Burden on Monetary Policy

34 Pages Posted: 21 Dec 2007 Last revised: 16 Nov 2022

See all articles by Ramon Marimon

Ramon Marimon

European University Institute

Javier Díaz Giménez

Charles III University of Madrid - Department of Economics

Giorgia Giovannetti

Università di Firenze

Pedro Teles

Federal Reserve Bank of Chicago; Centre for Economic Policy Research (CEPR)

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Date Written: December 2007

Abstract

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.

Suggested Citation

Marimon, Ramon and Díaz Giménez, Javier and Giovannetti, Giorgia and Teles, Pedro, Nominal Debt as a Burden on Monetary Policy (December 2007). NBER Working Paper No. w13677, Available at SSRN: https://ssrn.com/abstract=1077803

Ramon Marimon (Contact Author)

European University Institute ( email )

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Javier Díaz Giménez

Charles III University of Madrid - Department of Economics ( email )

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Giorgia Giovannetti

Università di Firenze ( email )

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Pedro Teles

Federal Reserve Bank of Chicago ( email )

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Centre for Economic Policy Research (CEPR)

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