Government Debt: A Key Role in Financial Intermediation

30 Pages Posted: 13 Jan 2006

See all articles by Michael Kumhof

Michael Kumhof

CEPR

Evan Tanner

International Monetary Fund (IMF) - Research Department

Date Written: March 2005

Abstract

The literature on optimal fiscal policy finds that highly volatile real returns on government debt, for example through surprise inflation, have very low costs. However, policymakers are almost always very apprehensive of this option. The paper discusses evidence concerning features of developing country financial markets that are missing in existing models, and that may suggest why this policy is considered so costly in practice. Most importantly, domestic banks choose to be highly exposed to government debt because the alternative, private lending, is more risky under existing legal and institutional imperfections. This exposure makes banks and their borrowers vulnerable to the government`s debt policy.

Keywords: Optimal fiscal policy, distortionary taxation, inflation, government debt

JEL Classification: E62, F34

Suggested Citation

Kumhof, Michael and Tanner, Evan C., Government Debt: A Key Role in Financial Intermediation (March 2005). IMF Working Paper No. 05/57, Available at SSRN: https://ssrn.com/abstract=874279

Michael Kumhof (Contact Author)

CEPR ( email )

London
United Kingdom

Evan C. Tanner

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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