A continuous-time model of the term structure of interest rates with fiscal-monetary policy interactions

Discussion Papers
A continuous-time model of the term structure of interest rates with fiscal-monetary policy interactions
25/2008
Author(s):
Massimiliano Marzo – Silvia Romagnoli – Paolo Zagaglia
2008. 35 pages.
Publisher:
Bank of Finland
ISBN:
978-952-462-466-4
(Printed publication)
ISBN:
978-952-462-467-1
(Web publication)
ISSN:
0785-3572
(Printed publication)
ISSN:
1456-6184
(Web publication)
 
We study the term structure implications of the fiscal theory of price level determination. We 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. We show how to solve for the prices of real and nominal zero coupon bonds.