A Continuous-Time Model Of The Term Structure Of Interest Rates With Fiscal-Monetary Policy Interactions
Source: Bank of Finland
The authors study the term structure implications of the fiscal theory of price level determination. They 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. They show how to solve for the prices of real and nominal zero coupon bonds. This paper is organized as follows. The first two sections introduce the reader to the framework employed to develop the analysis, together with a brief discussion on the fiscal and monetary policy rules adopted. Section 4 and 5, respectively, discuss the optimization process form the representative investor's side and the characterization of the equilibrium.