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Federal Reserve Bank of Chicago
Working Paper Series
Nominal debt as a burden on monetary policy
Javier Díaz-Giménez
Giorgia Giovannetti
Ramon Marimon
Pedro Teles
Abstract

We study the effects of nominal debt on the optimal sequential choice of monetary and debt 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 commitment to fiscal policy.


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Javier Díaz-Giménez & Giorgia Giovannetti & Ramon Marimon & Pedro Teles, Nominal debt as a burden on monetary policy, Federal Reserve Bank of Chicago, Working Paper Series WP-04-10, 2004.
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Keywords: Debts; Public ; Financial crises ; Fiscal policy ; Monetary policy
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