Time consistency of government financial policy in a small open economy

This paper derives sufficient conditions for the time-consistency of optimal fiscal policy in a small open economy. Results depend critically on the debt instruments used by the government. If the government employs only conventional debt, a sufficient condition for time-consistency is that the optimal policy equalizes tax rates across periods. If the government also issues consumption indexed debt, the optimal policy can always be made time consistent by an appropriate mix of conventional and indexed debt. For a specific example, a simple rule for indexed debt management can be derived.