Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 734: Time Consistency of Fiscal and Monetary Policy: A Solution

Mats Persson (), Torsten Persson () and Lars E.O. Svensson ()
Additional contact information
Mats Persson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden
Torsten Persson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden
Lars E.O. Svensson: Department of Economics, Princeton University, Postal: Department of Economics, Princeton University, Fisher Hall, Princeton, NJ 08544-1021, USA

Abstract: This paper demonstrates how time consistency of the Ramsey policy–the optimal fiscal and monetary policy under commitment–can be achieved. Each government should leave its successor with a unique maturity structure for the nominal and indexed debt, such that the marginal benefit of a surprise inflation exactly balances the marginal cost. Unlike in earlier papers on the topic, the result holds for quite a general Ramsey policy, including time varying polices with positive inflation and positive nominal interest rates. We compare our results with those in Persson, Persson, and Svensson (1987), Calvo and Obstfeld (1990), and Alvarez, Kehoe, and Neumeyer (2004).

Keywords: time consistency; Ramsey policy; surprise inflation

JEL-codes: E31; E52; H21

22 pages, October 1, 2004

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