NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Nominal Debt as a Burden on Monetary Policy

Ramon Marimon, Javier Díaz-Giménez, Giorgia Giovannetti, Pedro Teles

NBER Working Paper No. 13677
Issued in December 2007
NBER Program(s):   IFM   ME

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.

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Document Object Identifier (DOI): 10.3386/w13677

Published: Javier Diaz-Gimenez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, 2008. "Nominal Debt as a Burden on Monetary Policy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 493-514, July.

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