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

Hatcher, M. (2014) Indexed versus nominal government debt under inflation and price-level targeting. Journal of Economic Dynamics and Control, 45, pp. 126-145. (doi: 10.1016/j.jedc.2014.05.020)

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.

• Item Type: Articles
• Status: Published
• Refereed: Yes
• Glasgow Author(s) Enlighten ID: Hatcher, Dr Michael
• Authors: Hatcher, M.
• College/School: College of Social Sciences > Adam Smith Business School > Economics
• Journal Name: Journal of Economic Dynamics and Control
• Publisher: Elsevier
• ISSN: 0165-1889
• Published Online: 06 June 2014