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UCL Department of Economics

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Carlo Galli

Carlo Galli

Carlo Galli

Carlo Galli - Website

 

Research interests

Primary: Macroeconomics, International Finance.

Secondary: Information Economics.

Paper Title - 'Inflation, Default Risk and Nominal Debt'

Abstract:

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.

References

  • Professor Marco Bassetto
  • Dr Wei Cui
  • Professor Morten Ravn
  • Dr Manuel Amador