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This paper highlights the importance of debt composition in setting optimal fiscal and monetary policy over short-run business cycles and in the long run. Nominal debt as state-contingent debt can be a significant policy tool to reduce the volatility of distortionary government policy, thereby reducing macroeconomic volatility while increasing equilibrium output and consumption. The welfare gain from using nominal debt to hedge against shocks to the government budget is as large as the welfare gain from the ability to issue debt.

Debts, Public. --- Monetary policy. --- Fiscal policy. --- Tax policy --- Taxation --- Economic policy --- Finance, Public --- Monetary management --- Currency boards --- Money supply --- Debts, Government --- Government debts --- National debts --- Public debt --- Public debts --- Sovereign debt --- Debt --- Bonds --- Deficit financing --- Government policy --- Macroeconomics --- Money and Monetary Policy --- Public Finance --- Labor --- Financial Markets and the Macroeconomy --- Comparative or Joint Analysis of Fiscal and Monetary Policy --- Stabilization --- Treasury Policy --- Debt Management --- Sovereign Debt --- National Government Expenditures and Related Policies: General --- Macroeconomics: Consumption --- Saving --- Wealth --- Labor Economics: General --- Monetary Systems --- Standards --- Regimes --- Government and the Monetary System --- Payment Systems --- Personal Income and Other Nonbusiness Taxes and Subsidies --- Demand and Supply of Labor: General --- Public finance & taxation --- Labour --- income economics --- Monetary economics --- Welfare & benefit systems --- Expenditure --- Consumption --- Currencies --- Labor taxes --- National accounts --- Taxes --- Labor supply --- Expenditures, Public --- Economics --- Labor economics --- Money --- Income tax --- Labor market --- United States