Bonds with transactions service and optimal Ramsey policy

Yifan Hu, Timothy Kam*

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    Abstract

    We introduce a model of government bonds with transactions services into a standard dynamic stochastic general equilibrium sticky-price monetary economy. This additional feature results in an endogenous interest-rate spread and affects equilibrium allocations and inflation by altering the Ramsey planner's sequence of implementability and sticky-price constraints. Qualitatively, the trade-off confronting a planner in sticky-price models shown in recent literature, between using inflation surprise and labor-income tax, is eliminated by the liquid bond channel. We find that the more sticky prices become, the more the optimal fiscal-monetary policy stabilizes prices and also creates less distortionary and less volatile income taxes by taxing the liquidity service of bonds. Quantitatively, we show that the additional tax instrument created by the bond liquidity channel can yield a sizable welfare gain from an economy without this channel.

    Original languageEnglish
    Pages (from-to)633-653
    Number of pages21
    JournalJournal of Macroeconomics
    Volume31
    Issue number4
    DOIs
    Publication statusPublished - Dec 2009

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