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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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File URL: http://cbe.anu.edu.au/research/papers/camawpapers/Papers/2005/Hu_Kam_252005.pdf
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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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