Working Paper: NBER ID: w23612
Authors: Patrick Bolton; Haizhou Huang
Abstract: When a nation can finance its investments via foreign-currency denominated debt or domestic-currency claims, what is the optimal capital structure of the nation? Building on the functions of fiat money as both medium of exchange, and store of value like corporate equity, our model connects monetary economics, fiscal theory and international finance under a unified corporate finance perspective. With frictionless capital markets both a Modigliani-Miller theorem for nations and the classical quantity theory of money hold. With capital market frictions, a nation's optimal capital structure trades off inflation dilution costs and expected default costs on foreign-currency debt. Our framing focuses on the process by which new money claims enter the economy and the potential wealth redistribution costs of inflation.
Keywords: No keywords provided
JEL Codes: E5; E62; F3; F4; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| choice of financing method (debt vs. equity) (G32) | economic outcomes (F61) |
| relying more on printing money (E59) | perceived risk of inflation increases (E31) |
| perceived risk of inflation increases (E31) | higher dilution costs for holders of that currency (F31) |
| opting for foreign currency debt (F34) | risk of default (G33) |
| risk of default (G33) | deadweight costs (J32) |
| existing debt levels (H63) | deter investment decisions (G11) |