Nominal versus Indexed Debt: A Quantitative Horse Race
The main arguments in favor and against nominal and indexed debt are the incentive to default through inflation versus hedging against unforeseen shocks. We model and calibrate these arguments to assess their quantitative importance. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and contingent-debt service. Our framework also recognizes that contingent debt can be associated with incentive problems and lack of commitment. Thus, the benefits of unexpected inflation are tempered by higher interest rates. We obtain that costs from inflation more than offset the benefits from reducing tax distortions. We further discuss sustainability of nominal debt in developing (volatile) countries.
We thank Aloisio Araujo, Alicia García-Herrero, Nir Jaimovich, Julio Rotemberg, Carmen Reinhart and participants at 2nd International Conference on "Advances in Economic Research, Emerging Markets: Present Issues and Future Challenges," the 2005 LACEA Conference in France and the IMF and University of São Paulo seminars for valuable comments and suggestions. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Alfaro, Laura & Kanczuk, Fabio, 2010. "Nominal versus indexed debt: A quantitative horse race," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1706-1726, December. citation courtesy of