Carlo Galli - Website
Primary: Macroeconomics, International Finance.
Secondary: Information Economics.
Paper Title - 'Inflation, Default Risk and Nominal Debt'
This paper explores the trade-off between strategic inflation and default for a set of large emerging market economies that borrow mostly in their local currency. Using over-the-counter derivatives data, I find a robust, positive correlation between default risk, inflation risk, and realised inflation. I use these facts to discipline a quantitative sovereign default model where a government issues debt in domestic currency and lacks commitment to both fiscal and monetary policy. I show that simple models of debt dilution via default and inflation have counterfactual implications, as default and inflation are substitutes and co-move negatively. I highlight the role that monetary financing plays to match the data, allowing inflation to serve a second purpose: in bad times, seignorage is especially useful as a flexible source of funding when other margins may be hard to adjust. The model allows to quantitatively evaluate how the co-movement between inflation and default risks affects the trade-off between the insurance benefits of nominal debt and the ex-ante cost of a further source of time inconsistency.
- Professor Marco Bassetto
- Dr Wei Cui
- Professor Morten Ravn
- Dr Manuel Amador