Government Debt Management and Inflation with Real and Nominal Bonds

Lukas Schmid, Vytautas Valaitis and Alessandro Villa

No 18197, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Can governments use TIPS to tame inflation? We propose a novel framework of optimal debt management with sticky prices and a government that issues nominal and real state-uncontingent bonds. Nominal debt can be monetized giving ex-ante flexibility, whereas real bonds are cheaper but constitute a commitment ex-post. Under Full Commitment, the government chooses a leveraged portfolio of nominal liabilities and real assets to use inflation to smooth taxes. With No Commitment, it reduces borrowing costs ex-ante using real debt strategically to prevent future governments from monetizing debt ex-post. Such policies match U.S. data, with higher TIPS shares effectively curbing inflation.

JEL-codes: E44 E52 E62 G12 (search for similar items in EconPapers)
Date: 2023-06
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Working Paper: Government Debt Management and Inflation with Real and Nominal Bonds (2024)
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