Fiscal Hedging and the Yield Curve / Hanno Lustig, Christopher Sleet, Sevin Yeltekin.

Format:

Book

Author/Creator:

Lustig, Hanno.

Contributor:

National Bureau of Economic Research.

Sleet, Christopher.

Yeltekin, Sevin.

Series:

Working Paper Series (National Bureau of Economic Research) no. w11687.

NBER working paper series no. w11687

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2005.

Summary:

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.

Notes:

Print version record

October 2005.