Indexed versus nominal government debt under inflation and price-level targeting

Michael Hatcher

Journal of Economic Dynamics and Control, 2014, vol. 45, issue C, 126-145

Abstract: This paper presents a DSGE model in which long run inflation risk matters for social welfare. Optimal indexation of long-term government debt is studied under two monetary policy regimes: inflation targeting (IT) and price-level targeting (PT). Under IT, full indexation is optimal because long run inflation risk is substantial due to base-level drift, making indexed bonds a better store of value than nominal bonds. Under PT, where long run inflation risk is largely eliminated, optimal indexation is substantially lower because nominal bonds become a relatively better store of value. These results are robust to the PT target horizon, imperfect credibility of PT and model calibration, but the assumption that indexation is lagged is crucial. A key finding from a policy perspective is that indexation has implications for welfare comparisons of IT and PT.

Keywords: Government debt; Inflation risk; Inflation targeting; Price-level targeting (search for similar items in EconPapers)
JEL-codes: E52 E63 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (2)

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Working Paper: Indexed versus nominal government debt under inflation and price-level targeting (2013)
Working Paper: Indexed versus nominal government debt under inflation and price-level targeting (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:45:y:2014:i:c:p:126-145

DOI: 10.1016/j.jedc.2014.05.020

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