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Ramsey Fiscal And Monetary Policy Under Sticky Prices And Liquid Bonds

  • Yifan Hu
  • Timothy Kam

    ()

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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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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  2. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  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.
  13. 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.
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  18. Canzoneri, Matthew B. & Diba, Behzad T., 2005. "Interest rate rules and price determinacy: The role of transactions services of bonds," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 329-343, March.
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