RAMSEY FISCAL AND MONETARY POLICY UNDER STICKY PRICES AND LIQUID BONDS

Yifan Hu and Timothy Kam ()

ANUCBE School of Economics Working Papers from Australian National University, College of Business and Economics, School of Economics

Abstract: We construct a monetary model where government bonds also provide liquidity service. Liquid government bonds create an endogenous interest-rate spread; affect equilibrium allocations and inflation by altering the Ramsey planner’s sequence of implementability and sticky-price constraints. The trade-off confronting a planner in a sticky-price world, shown in recent literature, between using inflation surprise and labor-income tax is modified by the existence of the liquid bond. We find that the more sticky prices become, the more the planner stabilizes prices and also creates less distortionary and less volatile income taxes by taxing the liquidity service of bonds in order to replicate ex post real state-contingent debt.

JEL-codes: E42 E52 E63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2006-09
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