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  • 2005
  • Working Paper
  • HBS Working Paper Series

Nominal versus Indexed Debt: A Quantitative Horse Race

By: Laura Alfaro and Fabio Kanczuk
  • Format:Print
  • | Language:English
  • | Pages:33
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Abstract

The main arguments in favor of and against nominal and indexed debt are the incentive to default through inflation versus hedging against unforeseen shocks. We model and calibrate these arguments to assess their quantitative importance. We use a dynamic equilibrium model with tax distortion, government outlays uncertainty, and contingent-debt service. Our framework also recognizes that contingent debt can be associated with incentive problems and lack of commitment. Thus, the benefits of unexpected inflation are tempered by higher interest rates. We obtain that costs from inflation more than offset the benefits from reducing tax distortions. We further discuss sustainability of nominal debt in developing (volatile) countries.

Keywords

Borrowing and Debt; Taxation; Risk and Uncertainty; Inflation and Deflation; System Shocks; Developing Countries and Economies; Mathematical Methods

Citation

Alfaro, Laura, and Fabio Kanczuk. "Nominal versus Indexed Debt: A Quantitative Horse Race." Harvard Business School Working Paper, No. 05-053, January 2005. (Revised March 2010. Also NBER Working Paper No. 13131.)
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About The Author

Laura Alfaro

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  • The Real Exchange Rate, Innovation and Productivity By: Laura Alfaro, Alejandro Cuñat, Harald Fadinger and Yanping Liu
  • Doing Business in Boston, Massachusetts By: Laura Alfaro, Leonard A. Schlesinger and Zeke Gillman
  • Health Externalities and Policy: The Role of Social Preferences By: Laura Alfaro, Ester Faia, Nora Lamersdorf and Farzad Saidi
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