Discussion Paper Details

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Title: Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting

Author(s): Kevin D. Sheedy

Publication Date: February 2014

Keyword(s): heterogeneous agents, incomplete markets, nominal GDP targeting and risk sharing

Programme Area(s): International Macroeconomics

Abstract: Financial markets are incomplete, thus for many households borrowing is possible only by accepting a financial contract that specifies a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be inefficiently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating households' nominal incomes from aggregate real shocks, this policy effectively completes financial markets by stabilizing the ratio of debt to income. The paper argues the objective of replicating complete financial markets should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.

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Bibliographic Reference

Sheedy, K. 2014. 'Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting'. London, Centre for Economic Policy Research.