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Ramsey Fiscal And Monetary Policy Under Sticky Prices And Liquid Bonds

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  • Yifan Hu
  • Timothy Kam

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    Abstract

    We construct a monetary model where government bonds also provide liquidity service. Liquid government bonds affect equilibrium allocations, inflation and create an endogenous interest-rate spread. How this new feature alters optimal fiscal-monetary policy in a stochastic sticky-price environment is considered. The trade-off confronting a planner, shown in recent literature, between using inflation surprise and labor-income tax is eradicated by the existence of the liquid bond. We find that the more sticky prices become, the more the planner stabilizes prices, but the planner also creates less distortionary and less volatile income taxes by resorting to taxing the liquidity service of bonds.

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    Bibliographic Info

    Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2005-26.

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    Length: 31 pages
    Date of creation: Dec 2005
    Date of revision:
    Handle: RePEc:een:camaaa:2005-26

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    1. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
    2. S. Boragan Aruoba & Jesus Fernandez-Villaverde & Juan Francisco Rubio-Ramirez, 2003. "Comparing solution methods for dynamic equilibrium economies," Working Paper 2003-27, Federal Reserve Bank of Atlanta.
    3. Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
    4. Giovannini, Alberto & Labadie, Pamela, 1991. "Asset Prices and Interest Rates in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1215-51, December.
    5. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
    6. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, December.
    7. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
    8. Ricardo Lagos, 2006. "Asset prices and liquidity in an exchange economy," Staff Report 373, Federal Reserve Bank of Minneapolis.
    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. 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.
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