Nominal Debt as a Burden on Monetary Policy

UPF Economics and Business Working Paper 841

26 Pages Posted: 30 Nov 2005

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

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Pedro Teles

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

Multiple version iconThere are 4 versions of this paper

Date Written: July 2004

Abstract

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.

Keywords: Time-consistency, Monetary Policy, Debt, Recursive Equilibrium

JEL Classification: E40, E52, E61

Suggested Citation

Díaz Giménez, Javier and Giovannetti, Giorgia and Marimon, Ramon and Teles, Pedro, Nominal Debt as a Burden on Monetary Policy (July 2004). UPF Economics and Business Working Paper 841, Available at SSRN: https://ssrn.com/abstract=860645 or http://dx.doi.org/10.2139/ssrn.860645

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 (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2707 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/crei/people/marimon/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Pedro Teles

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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