Abstract
The size and the structure of public debt play an important role in the macroeconomic environment and can even affect the decision-making process at the firm level. The recognition of this fact and the rising debt levels in the 1980’s and part of the 1990’s for many OECD countries have generated a renewed, buoyant interest in the subject. From an academic standpoint, this interest has led to a plethora of theoretical and empirical contributions during the last two decades. As a result, the implications of debt policies are now better understood. Moreover, policy-making has also progressed as the design and implementation of fiscal policies have become more transparent and sophisticated. In several cases, governments have established specialised agencies with the aim of monitoring closely the developments in the debt markets and delivering ‘optimal’ debt policies. This project examines several aspects of the relation between inflation and the level and structure of government debt. First, we ask to what extent higher debt levels result in higher inflation rates. Results from this exercise are a useful reminder to policy-makers of the importance of fiscal policy. In a subsequent chapter we examine the effect of inflation on the choice of government debt structure. We develop a model to allow for the joint determination of inflation and the share of inflation-sensitive securities. We assume that governments have a preference for nominal long-term debt in domestic currency. We show that the subgame perfect equilibrium involves a negative relation between inflationary expectations and the share of such debt. Panel data estimation for fifteen OECD countries provides strong support for the theory. Finally, we are concerned with the issue of whether price-indexed debt insulates the budget from macroeconomic disturbances. In other words, we ask what type of debt is optimal from a tax-smoothing perspective. Results are highly relevant to the implementation of optimal debt strategies.