Inflation Target and Debt Management of Local Government Bonds

42 Pages Posted: 30 Apr 2011 Last revised: 13 Dec 2011

See all articles by Hiroshi Fujiki

Hiroshi Fujiki

Chuo University - Faculty of Commerce

Hirofumi Uchida

Kobe University - Graduate School of Business Administration

Date Written: July 6, 2011

Abstract

We show that the optimal inflation target imposed on a discretionary central bank varies with the extent of fiscal decentralization. Our analysis compares two fiscal regimes for local government bond management: the partially decentralized (PD) regime where the central government determines the amount of local bond; and the fully decentralized (FD) regime where each local government determines the amount of local bond. In both regimes, an inflation target has two effects: it harnesses surprise inflation; and it induces excess issuance of local bonds. Due to externality in determining the level of local government bond, however, the second effect, and thereby the optimal level of the inflation target, are smaller in the FD regime than in the PD regime. We also find that even if fiscal decentralization in its isolation deteriorates social welfare, we may be able to improve social welfare by introducing an inflation target when fiscal decentralization measures are adopted.

Keywords: Fiscal decentralization, Government bond management, Externality, Inflation targets, Fiscal discipline

JEL Classification: E52, H11, H7

Suggested Citation

Fujiki, Hiroshi and Uchida, Hirofumi, Inflation Target and Debt Management of Local Government Bonds (July 6, 2011). Japan and the World Economy, Vol. 23, No. 3, 2011, Available at SSRN: https://ssrn.com/abstract=926974

Hiroshi Fujiki

Chuo University - Faculty of Commerce ( email )

742-1, Higashinakano
Hacihoji
Tokyo, 192-0393
Japan

Hirofumi Uchida (Contact Author)

Kobe University - Graduate School of Business Administration ( email )

2-1, Rokkodai-cho, Nada-ku
Kobe, 657-8501
Japan
81-78-803-6949 (Phone)

HOME PAGE: http://www.b.kobe-u.ac.jp/~uchida

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