Tepper School of Business
Carnegie Mellon University
Pittsburgh, PA 15213
Institutional Affiliation: Carnegie Mellon University
NBER Working Papers and Publications
|October 2005||Fiscal Hedging and the Yield Curve|
with Hanno Lustig, Sevin Yeltekin: w11687
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 ...
Published: Lustig, Hanno, Chris Sleet, and Sevin Yeltekin. "Fiscal Hedging with Nominal Assets." Journal of Monetary Economics 55, 4(2008).