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Bonds with transactions service and optimal Ramsey policy

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  • Hu, Yifan
  • Kam, Timothy
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    Abstract

    We introduce a model of government bonds with transactions services into a standard dynamic stochastic general equilibrium sticky-price monetary economy. This additional feature results in an endogenous interest-rate spread and affects equilibrium allocations and inflation by altering the Ramsey planner's sequence of implementability and sticky-price constraints. Qualitatively, the trade-off confronting a planner in sticky-price models shown in recent literature, between using inflation surprise and labor-income tax, is eliminated by the liquid bond channel. We find that the more sticky prices become, the more the optimal fiscal-monetary policy stabilizes prices and also creates less distortionary and less volatile income taxes by taxing the liquidity service of bonds. Quantitatively, we show that the additional tax instrument created by the bond liquidity channel can yield a sizable welfare gain from an economy without this channel.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Macroeconomics.

    Volume (Year): 31 (2009)
    Issue (Month): 4 (December)
    Pages: 633-653

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    Handle: RePEc:eee:jmacro:v:31:y:2009:i:4:p:633-653

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    Web page: http://www.elsevier.com/locate/inca/622617

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    Keywords: Optimal fiscal and monetary policy Sticky prices Liquid bonds;

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    1. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Proceedings, Federal Reserve Bank of Cleveland, pages 519-546.
    2. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
    3. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
    4. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
    5. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    6. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
    7. Alberto Giovannini & Pamela Labadie, 1989. "Asset Prices and Interest Rates in Cash-In-Advance Models," NBER Working Papers 3109, National Bureau of Economic Research, Inc.
    8. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
    9. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-71, December.
    10. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under sticky prices," Journal of Economic Theory, Elsevier, vol. 114(2), pages 198-230, February.
    11. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad T., 2007. "Euler equations and money market interest rates: A challenge for monetary policy models," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1863-1881, October.
    12. Calvo, Guillermo A & Guidotti, Pablo E, 1993. "On the Flexibility of Monetary Policy: The Case of the Optimal Inflation Tax," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 667-87, July.
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