Abstract
We take a corporate finance approach to the question of countries' funding of investments via foreign-currency denominated debt or domestic-currency claims. We ask what is the optimal capital structure of a nation? A key conceptual innovation we introduce is an analogy between a nation's money-claims and corporate equity. What a nation's money and a firm's equity have in common is that they both are claims on residual output. Pursuing this analogy, we show that a nation's optimal funding structure can be characterized as the solution to a tradeoff between inflation costs and expected default costs. Our corporate finance perspective provides a unified framework integrating corporate finance, monetary economics, fiscal theory and international finance. It yields new insights into such issues as the costs and benefits of foreign exchange reserves and the optimal currency composition of sovereign debt.
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