Author: Michael Hatcher
Paper Number: 1505
Abstract
This paper presents a DSGE model in which the government issues short and long-term nominal debt. The model is used to compare social welfare under inflation targeting (IT) and price-level targeting (PT) monetary regimes. When the share of long-term debt is calibrated to be positive as in the data, PT raises social welfare relative to IT because it lowers long-term inflation risk. However, if the share of long-term debt is set optimally to maximise social welfare, the welfare gains of PT are eliminated because only short-term debt should be issued. These results are robust to calibration, but the presence of productivity risk is crucial.