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

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  • Hatcher, Michael

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.

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  • Hatcher, Michael, 2014. "Indexed versus nominal government debt under inflation and price-level targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 126-145.
    • Handle: RePEc:eee:dyncon:v:45:y:2014:i:c:p:126-145
    DOI: 10.1016/j.jedc.2014.05.020
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    1. Westerhout, Ed, 2021. "Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies," Other publications TiSEM ee384b1f-4e6f-4f30-821e-d, Tilburg University, School of Economics and Management.
    2. Westerhout, Ed, 2021. "Inflation-Linked Bonds, Nominal Bonds, and Countercyclical Monetary Policies," Discussion Paper 2021-001, Tilburg University, Center for Economic Research.

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    More about this item

    Keywords

    Government debt; Inflation risk; Inflation targeting; Price-level targeting;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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