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Government Debt Management and Inflation with Real and Nominal Bonds

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  • Schmid, Lukas
  • Valaitis, Vytautas
  • Villa, Alessandro

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.

Suggested Citation

  • Schmid, Lukas & Valaitis, Vytautas & Villa, Alessandro, 2023. "Government Debt Management and Inflation with Real and Nominal Bonds," CEPR Discussion Papers 18197, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18197
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    1. Leeper, Eric M. & Leith, Campbell & Liu, Ding, 2021. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 600-617.
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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