A2010
Title: Government debt management and inflation with real and nominal bonds
Authors: Alessandro Villa - Federal Reserve Bank of Chicago (United States) [presenting]
Abstract: In the wake of rising inflation in the aftermath of unprecedented debt-financed stimulus packages, the question is: Can governments use real bonds (TIPS) as part of their debt portfolio to commit to stable inflation rates? We propose a novel framework of optimal debt management in the presence of sticky prices with a government that can issue nominal and real non-state-contingent bonds. Nominal debt can be inflated away, giving ex-ante flexibility, whereas real bonds are cheaper but constitute a real commitment ex-post. Under Full Commitment, the government chooses a leveraged portfolio of nominal liabilities and real assets to use inflation effectively to smooth fiscal policy. When the government cannot commit to future policies, it reduces borrowing costs ex-ante using real debt strategically to mitigate incentives for the future government to monetize debt ex-post. Without commitment, the policies are quantitatively consistent with US data, suggesting that such a framework realistically captures the relevant constraints governments face.
