Nominal debt and inflation stabilization

Shigeto Kitano

International Journal of Economic Theory, 2009, vol. 5, issue 4, 409-422

Abstract: The “fiscal theory of currency crises” (Daniel 2001; Corsetti and Maćkowiak 2005, 2006) claims that with long‐term nominal debt, a government can delay the timing of an inevitable currency crisis that results from a fiscal shock. The present paper shows that, in contrast, long‐term nominal debt might have destabilizing effects when a government introduces an inflation stabilization policy. It is shown that a stabilization policy that is successful in the absence of long‐term nominal debt can cause a crisis when long‐term nominal debt exists. The model implies that a government with a large stock of long‐term nominal debt must overcome a high fiscal hurdle for a successful stabilization policy. This difficulty is avoidable if long‐term debt is indexed to inflation.

Date: 2009
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https://doi.org/10.1111/j.1742-7363.2009.00116.x

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