Monetary Policy and Sovereign Debt Vulnerability

Carlos Thomas and Galo Nuño
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Galo Nuño: Banco de España
Authors registered in the RePEc Author Service: Galo Nuño Barrau

No 329, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We investigate the trade-o¤s between price stability and sovereign debt sustainability, in a small-open-economy model where the government issues nominal debt without committing not to default or inflate. Inflation allows to absorb the e¤ect of aggregate shocks on the debt ratio, which improves sovereign debt sustainability. But the government incurs an ‘inflationary bias’: it creates (costly) inflation even when default is distant. For plausible calibrations, we find that abandoning the ability to inflate debt away raises welfare, even when the economy is close to default: the benefits from eliminating the inflationary bias dominate the costs from losing inflation’s debt-stabilizing role.

Date: 2016
New Economics Papers: this item is included in nep-cba, nep-cse, nep-dge, nep-mac, nep-mon and nep-opm
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Citations: View citations in EconPapers (5)

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Related works:
Working Paper: Monetary policy and sovereign debt vulnerability (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:329

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