Nominal Sovereign Debt

Abstract

I show that reputation alone can sustain nominal sovereign debt, which is subject to both the risks of default and opportunistic devaluations. Nominal debt combined with a countercyclical exchange rate policy allows more hedging against shocks than real savings if markets are incomplete. Thus, the loss of either repayment or monetary reputation severely affects the government’s ability to smooth consumption. The model offers a simple explanation for the Bulow and Rogoff critique, while simultaneously helps explain the issuance of nominal sovereign bonds by emerging economies. The model also helps explain why many governments borrow and save at the same time.

Keywords: sovereign debt; inflation; sustainable policies

JEL Classification: F34; F4; H63