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Sustaining a Time-Consistent Ramsey Plan with Options

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  • Francois Velde
  • Thomas Sargent

Abstract

Where the state evolves according to a discrete-state Markov chain, we sustain Lucas and Stokey's debt structure dynamics by having it emerge sequentially as the unique outcome of a sequence of choices made by two sequences of independent government departments. Each period a tax authority sets taxes, taking the debt structure as given. Each period, a debt management authority exercises a financial option that it has inherited, then structures another financial option to hand down to the successor debt management authority. We exhibit equilibrium continuation government coupons in this Markov setting and how they can be interpreted as implementing a particular European call option. We interpret these European calls as a simple instance of the `five-twenties' (callable after five years, redeemable after twenty) that the U.S. used to finance itself during the War of Rebellion

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 607.

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Date of creation: 2004
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Handle: RePEc:red:sed004:607

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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Keywords: optimal fiscal policy; time-consistency; options;

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