Sustaining a Time-Consistent Ramsey Plan with Options

Francois Velde () and Thomas Sargent ()

No 607, 2004 Meeting Papers from Society for Economic Dynamics

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

Keywords: optimal fiscal policy; time-consistency; options (search for similar items in EconPapers)
JEL-codes: E61 E62 (search for similar items in EconPapers)
Date: 2004

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Persistent link: http://EconPapers.repec.org/RePEc:red:sed004:607

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