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Is The Fiscal Theory of the Price Level Learnable?

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  • Bennett T. McCallum

Abstract

This paper presents a prototype model for development of the “fiscal theory of the price level.” In this simple setting, the fiscal theory’s distinctiveness relies upon adoption of a bubble solution, rather than the rational-expectations fundamentals solution. The paper then shows that the fiscal solution is not adaptively learnable, by agents who estimate coefficients relevant for forecasting on the basis of available data, whereas the orthodox “monetarist” solution exists and is learnable. Finally, it is argued that similar results should be expected to apply in more complex models. JEL Nos. E5, E6, D8. Keywords: Monetary theory, fiscal theory, price level determination, learning, rational expectations.

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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2003-24.

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Handle: RePEc:cmu:gsiawp:1268904776

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Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
Web page: http://www.tepper.cmu.edu/

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  1. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  2. W.H. Buiter, 2000. "The Fallacy of the Fiscal Theory of the Price Level," CEP Discussion Papers dp0447, Centre for Economic Performance, LSE.
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  7. Bennett T. McCallum, 2002. "The Unique Minimum State Variable RE Soluiton is E-Stable in All Well Formulated Linear Models," GSIA Working Papers 2003-25, Carnegie Mellon University, Tepper School of Business.
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  9. Bennett T. McCallum, 1999. "Theoretical Issues Pertaining to Monetary Unions," NBER Working Papers 7393, National Bureau of Economic Research, Inc.
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  32. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, vol. 4(3), pages 381-99.
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