Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 2008:6: A Continuous-Time Model of the Term Structure of Interest Rates with Fiscal-Monetary Policy Interactions

Massimiliano Marzo (), Silvia Romagnoli () and Paolo Zagaglia
Additional contact information
Massimiliano Marzo: Universita di Bologna;, Postal: Department of Economics, Universita di Bologna, Strada Maggiore, 45 Bologna, Italy
Silvia Romagnoli: Universita di Bologna, Postal: Department of Mathematics, Universita di Bologna, Viale Filopanti, 5 Bologna, Italy
Paolo Zagaglia: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden. Research Unit, Bank of Finland, Finland

Abstract: We study the term structure implications of the fiscal theory of price level determination. We introduce the intertemporal budget constraint of the government in a general equilibrium model in continuous time. Fiscal policy is set according to a simple rule whereby taxes react proportionally to real debt. We show how to solve for the prices of real and nominal zero coupon bonds.

Keywords: Bond Pricing; Fiscal Policy; Mathematical Methods

JEL-codes: D90; G12

27 pages, July 29, 2008

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