Liquidity Premiums on Government Debt and the Fiscal Theory of the Price Level

Aleksander Berentsen and Christopher Waller

No 2017-8, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We construct a dynamic general equilibrium model where agents use nominal government bonds as collateral in secured lending arrangements. If the collateral constraint binds, agents price in a liquidity premium on bonds that lowers the real rate on bonds. In equilibrium, the price level is determined according to the fiscal theory of the price level. However, the market value of government debt exceeds its fundamental value. We then examine the dynamic properties of the model and show that the market value of the government debt can fluctuate even though there are no changes to current or future taxes or spending. The price dynamics are driven solely by the liquidity premium on the debt.

Keywords: Price level; Fiscal Policy; Liquidity (search for similar items in EconPapers)
JEL-codes: E31 E62 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2017-03-29
New Economics Papers: this item is included in nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Liquidity premiums on government debt and the fiscal theory of the price level (2018)
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DOI: 10.20955/wp.2017.008

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