TY  - JOUR
AU  - Lustig,Hanno
AU  - Sleet,Christopher
AU  - Yeltekin,Sevin
TI  - Fiscal Hedging and the Yield Curve
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11687
PY  - 2005
Y2  - October 2005
UR  - http://www.nber.org/papers/w11687
L1  - http://www.nber.org/papers/w11687.pdf
N1  - Author contact info:
Hanno Lustig
UCLA Anderson School of Management
110 Westwood Plaza, Suite C413
Los Angeles, CA 90095-1481
Tel: 310/825-1011
Fax: 310/825-9528
E-Mail: hlustig@anderson.ucla.edu

Christopher Sleet
Department of Economics
University of Iowa
Iowa City, IA  52242
E-Mail: christopher-sleet@uiowa.edu

Sevin Yeltekin
Northwestern University
Kellogg School of Management
2001 Sheridan Road, 5th Floor
Evanston, IL  60208
E-Mail: sevin@andrew.cmu.edu
AB  - We identify a novel, fiscal hedging motive that helps to explain why governments issue more expensive, long-term debt. We analyze optimal fiscal policy in an economy with distortionary labor income taxes, nominal rigidities and nominal debt of various maturities. The government in our model can smooth labor tax rates by changing the real return it pays on its outstanding liabilities. These changes require state contingent inflation or adjustments in the nominal term structure. In the presence of nominal pricing rigidities and a cash in advance constraint, these changes are themselves distortionary. We show that long term nominal debt can help a government hedge fiscal shocks by spreading out and delaying the distortions associated with increases in nominal interest rates over the maturity of the outstanding long-term debt. After a positive spending shock, the government raises the yield curve and steepens it.
ER  -