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Policy Interaction, Learning and the Fiscal Theory of Prices

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  • Evans, G W
  • Honkapohja, Seppo

Abstract

We investigate both the rational explosive inflation paths studied by McCallum (2001), and the classification of fiscal and monetary policies proposed by Leeper (1991), for stability under learning of the rational expectations equilibria (REE). Our first result is that the fiscalist REE in the model of McCallum (2001) is not locally stable under learning. In contrast, in the setting of Leeper (1991), different possibilities can arise. We find, in particular, that there are parameter domains for which the fiscal theory solution, in which fiscal variables affect the price level, can be a stable outcome under learning. For other parameter domains, however, the monetarist solution is instead the stable equilibrium.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3564.

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Date of creation: Oct 2002
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Handle: RePEc:cpr:ceprdp:3564

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Keywords: expectations; explosive price paths; fiscal and monetary policy; inflation;

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  1. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589833, April.
  2. Willem H. Buiter, 1998. "The Young Person's Guide to Neutrality, Price Level Indeterminacy, Interest Rate Pegs, and Fiscal Theories of the Price Level," NBER Working Papers 6396, National Bureau of Economic Research, Inc.
  3. repec:cup:macdyn:v:2:y:1998:i:2:p:156-82 is not listed on IDEAS
  4. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589826, April.
  5. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  6. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  7. Evans, George W. & Ramey, Garey, 1998. "Calculation, Adaptation And Rational Expectations," Macroeconomic Dynamics, Cambridge University Press, vol. 2(02), pages 156-182, June.
  8. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  9. McCallum, Bennett T., 2001. "Indeterminacy, bubbles, and the fiscal theory of price level determination," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 19-30, February.
  10. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  11. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
  12. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589819, April.
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