A comparison of nominal and indexed debt under fiscal constraints. (March 2019) - Westerhout, Ed
Highlights: We compare welfare indexed and nominal public debt in presence fiscal constraints. Regulation taxes or public consumption to avoid violation constraints. Under a debt constraint indexed debt is generally preferred. Inflation persistence and larger maturity tend to magnify welfare differences. Link instruments to actual vs structural nominal GDP affects welfare differences. Abstract: This paper makes a welfare comparison between the issuance of price-indexed and nominal public debt in the presence of fiscal constraints, viz. a debt constraint, a deficit constraint and a combination of both. Distortionary taxes or public consumption are regulated to avoid the violation of the relevant fiscal constraint(s). Under a debt constraint indexed debt is generally preferred, while under a deficit constraint the results are more mixed. Introducing inflation persistence and raising the maturity of the debt tend to increase the magnitude of the welfare differences between the two types of debt. Welfare differences are further affected by the degree to which public consumption and tax revenues are indexed to actual versus structural nominal GDP.