Time Consistency of Fiscal and Monetary Policy: A Solution

25 Pages Posted: 22 Jul 2005

See all articles by Torsten Persson

Torsten Persson

Stockholm University - Institute for International Economic Studies (IIES); London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Mats Persson

Stockholm University; CESifo (Center for Economic Studies and Ifo Institute)

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: March 2005

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 general Ramsey policies, 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 Classification: E31, E52, H21

Suggested Citation

Persson, Torsten and Persson, Mats and Svensson, Lars E.O., Time Consistency of Fiscal and Monetary Policy: A Solution (March 2005). CEPR Discussion Paper No. 4941. Available at SSRN: https://ssrn.com/abstract=763686

Torsten Persson (Contact Author)

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 8 163066 (Phone)
+46 8 164177 (Fax)

London School of Economics & Political Science (LSE)

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Mats Persson

Stockholm University ( email )

Stockholm, SE-10691
Sweden

HOME PAGE: http://www.cesifo.de

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Lars E.O. Svensson

Stockholm School of Economics ( email )

PO Box 6501
Stockholm, 11383
Sweden

HOME PAGE: http://larseosvensson.se

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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