Econometrica: Nov 1987, Volume 55, Issue 6

Time Consistency of Fiscal and Monetary Policy

https://doi.org/0012-9682(198711)55:6<1419:TCOFAM>2.0.CO;2-0
p. 1419-1431

Lars E. O. Svensson, Mats Persson, Torsten Persson

The problem of time inconsistency arises from two different sources. First, as shown by Calvo (1978), there is an incentive for each government to engage in an initial unanticipated inflation. Second, as discussed by Lucas and Stokey (1983), there is an incentive for each government to deviate from the path of taxes announced by the preceding government. In this paper it is shown that these two sources of time inconsistency can be removed by a particular method of debt management, involving both nominal and indexed government bonds of various maturities.

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