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Fiscal Hedging and the Yield Curve

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  • Hanno Lustig
  • Christopher Sleet
  • Sevin Yeltekin

Abstract

We identify a novel, fiscal hedging motive that helps to explain why governments issue more expensive, long-term debt. We analyze optimal fiscal policy in an economy with distortionary labor income taxes, nominal rigidities and nominal debt of various maturities. The government in our model can smooth labor tax rates by changing the real return it pays on its outstanding liabilities. These changes require state contingent inflation or adjustments in the nominal term structure. In the presence of nominal pricing rigidities and a cash in advance constraint, these changes are themselves distortionary. We show that long term nominal debt can help a government hedge fiscal shocks by spreading out and delaying the distortions associated with increases in nominal interest rates over the maturity of the outstanding long-term debt. After a positive spending shock, the government raises the yield curve and steepens it.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11687.

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Date of creation: Oct 2005
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Publication status: published as Lustig, Hanno, Chris Sleet, and Sevin Yeltekin. "Fiscal Hedging with Nominal Assets." Journal of Monetary Economics 55, 4(2008).
Handle: RePEc:nbr:nberwo:11687

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  1. Alessandro Missale & Olivier Jean Blanchard, 1991. "The Debt Burden and Debt Maturity," NBER Working Papers 3944, National Bureau of Economic Research, Inc.
  2. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 531-554, April.
  3. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2008. "Optimal fiscal and monetary policy: equivalence results," Staff Report 403, Federal Reserve Bank of Minneapolis.
  4. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1105-1131, August.
  5. Qiang Dai & Thomas Philippon, 2005. "Fiscal Policy and the Term Structure of Interest Rates," NBER Working Papers 11574, National Bureau of Economic Research, Inc.
  6. 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.
  7. Campbell, John, 1995. "Some Lessons from the Yield Curve," Scholarly Articles 3163264, Harvard University Department of Economics.
  8. 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.
  9. Takashi Kamihigashi, 2000. "Necessity of Transversality Conditions for Stochastic Problems," Discussion Paper Series 115, Research Institute for Economics & Business Administration, Kobe University.
  10. Robert J. Barro, 1995. "Optimal Debt Management," NBER Working Papers 5327, National Bureau of Economic Research, Inc.
  11. Sevin Yeltekin & Hanno Lustig & Chris Sleet, 2004. "Does the US government hedge against government expenditure risk?," 2004 Meeting Papers 48, Society for Economic Dynamics.
  12. Fernando Lefort & Klaus Schmidt-Hebbel, 2002. "Indexation, Inflation and Monetary Policy: An Overview," Central Banking, Analysis, and Economic Policies Book Series, in: Fernando Lefort & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Serie (ed.), Indexation, Inflation and MOnetary Policy, edition 1, volume 2, chapter 1, pages 001-018 Central Bank of Chile.
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Cited by:
  1. Ananth Ramanarayanan & Cristina Arellano, 2008. "Default and the Maturity Structure in Sovereign Bonds," 2008 Meeting Papers 479, Society for Economic Dynamics.
  2. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 199-234.

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