Time Consistency of Fiscal and Monetary Policy

Abstract

The problem of time inconsistency arises from two different sources. First, as shown by Guillermo A. Calvo (1978), the re is an incentive for each government to engage in an initial unanti cipated inflation. Second, as discussed by Robert E. Lucas and Nancy L. Stokey (1983), there is an incentive for each government to deviat e from the path of taxes announced by the preceding government. In th is paper, it is shown that these two sources of time inconsistency ca n be removed by a particular method of debt management, involving bot h nominal and indexed government bonds of various maturities. Copyright 1987 by The Econometric Society.