Fed in Print might experience downtime on Thursday, May 22, due to scheduled maintenance. We apologize for any inconvenience.

Journal Article

On the benefits of GDP-indexed government debt: lessons from a model of sovereign defaults


Abstract: Whether governments should issue GDP-indexed sovereign debt continues to be the subject of policy debates. This article contributes to this debate by studying the effects of issuing GDP-indexed sovereign debt contracts using the equilibrium default model studied by Aguiar and Gopinath (2006) and Arellano (2008). We consider an extension with perfect indexation, i.e., the government issues Arrow-Debreu securities with payoffs that depend on the next-period aggregate income realization. The ex-ante welfare gain from the introduction of income-indexed bonds is equivalent to a permanent increase in consumption of 0.5 percent. Introducing income-indexed bonds results in welfare gains because it 1) eliminates defaults, 2) increases the average level of debt, and 3) reduces the volatility of consumption.

Access Documents

Authors

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Economic Quarterly

Publication Date: 2012

Volume: 98

Issue: 2Q

Pages: 139-157