A Continuous-Time Model of the Term Structure of Interest Rates with Fiscal-Monetary Policy Interactions
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.
Introduction: The theory of price level determination advocated by Leeper (1991), Sims (1994),Woodford (1996) and Cochrane (1998) has brought to the attention of macroe-conomists the role of interactions between fiscal and monetary policy. In a nutshell,the idea is that the price level is determined by the degree of solvency of the govern-ment. If the expected primary surplus is not su±cient to comply with the intertem-poral budget constraint of the government, then part of the public debt should…
Author: Massimiliano Marzo,Silvia Romagnoli,Paolo Zagaglia
Source: Department of Economics,Stockholm University
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