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Inflation target and debt management of local government bonds

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  • Fujiki, Hiroshi
  • Uchida, Hirofumi

Abstract

We show that the optimal inflation target imposed on a discretionary central bank varies with the extent of fiscal decentralization. Our analysis compares two fiscal regimes for local government bond management: the partially decentralized (PD) regime where the central government determines the amount of local bond; and the fully decentralized (FD) regime where each local government determines the amount of local bond. In both regimes, an inflation target has two effects: it harnesses surprise inflation; and it induces excess issuance of local bonds. Due to externality in determining the level of local government bond, however, the second effect, and thereby the optimal level of the inflation target, are smaller in the FD regime than in the PD regime. We also find that even if fiscal decentralization in its isolation deteriorates social welfare, we may be able to improve social welfare by introducing an inflation target when fiscal decentralization measures are adopted.

Suggested Citation

  • Fujiki, Hiroshi & Uchida, Hirofumi, 2011. "Inflation target and debt management of local government bonds," Japan and the World Economy, Elsevier, vol. 23(3), pages 178-189.
    • Handle: RePEc:eee:japwor:v:23:y:2011:i:3:p:178-189
    DOI: 10.1016/j.japwor.2011.07.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Fiscal decentralization; Government bond management; Externality; Inflation targets; Fiscal discipline; E52; H11; H7;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • H7 - Public Economics - - State and Local Government; Intergovernmental Relations

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