Nominal Debt as a Burden on Monetary Policy

36 Pages Posted: 9 Jun 2008

See all articles by Javier Díaz Giménez

Javier Díaz Giménez

Charles III University of Madrid - Department of Economics

Giorgia Giovannetti

Università di Firenze

Ramon Marimon

European University Institute

Pedro Teles

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

Multiple version iconThere are 4 versions of this paper

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.

Keywords: indexed debt, Markov-perfect equilibrium, nominal debt, optimal monetary policy, time consistency

JEL Classification: E40, E50, E58, E60

Suggested Citation

Díaz Giménez, Javier and Giovannetti, Giorgia and Marimon, Ramon and Teles, Pedro, Nominal Debt as a Burden on Monetary Policy (December 2007). CEPR Discussion Paper No. DP6595, Available at SSRN: https://ssrn.com/abstract=1140524

Javier Díaz Giménez

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

Calle Madrid 126
Getafe, 28903
Spain
+34 91 624 9585 (Phone)
+34 91 624 9875 (Fax)

Giorgia Giovannetti

Università di Firenze ( email )

Piazza di San Marco, 4
Florence, 50121
Italy

Ramon Marimon

European University Institute ( email )

Via delle Fontanelle 18
San Domenico di Fiesole, 50014
Italy
00390554685809 (Phone)

Pedro Teles (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States
312-322-2947 (Phone)
312-322-2357 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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