The Capital Structure of Nations*

Welfare analysis of currency regimes with defaultable debts

Patrick Bolton and Haizhou Huang

Review of Finance, 2018, vol. 22, issue 1, 45-82

Abstract: When a nation can finance its investments via foreign-currency denominated debt or domestic-currency claims, what is the optimal capital structure of the nation? Building on the functions of fiat money as both medium of exchange, and store of value like corporate equity, our model connects monetary economics, fiscal theory, and international finance under a unified corporate finance perspective. With frictionless capital markets both a Modigliani–Miller theorem for nations and the classical quantity theory of money hold. With capital market frictions, a nation’s optimal capital structure trades off inflation dilution costs and expected default costs on foreign-currency debt. Our framing focuses on the process by which new money claims enter the economy and the potential wealth redistribution costs of inflation.

Keywords: Fiat Money; Inflation; Equity; Foreign-currency Debt; Foreign-currency reserves (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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