Time Consistency of Fiscal and Monetary Policy – Abstract

Revised version PDF Working-paper version with numerical examples PDF MatLab programs

Mats Persson
Institute for International Economic Studies

Torsten Persson
Institute for International Economic Studies

Lars E.O. Svensson
Princeton University

First draft: October 2004
This version: August 2005

74 (2006) 193-212

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 timevarying 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).

JEL Classification: E310, E520, H210
Keywords: time consistency, Ramsey policy, surprise inflation