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Learning the fiscal theory of the price level: some consequences of debt management policy

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  • Stefano Eusepi
  • Bruce Preston

Abstract

This paper examines how the scale and composition of public debt can affect economies that implement a combination of “passive” monetary policy and “active” fiscal policy. This policy configuration is argued to be of both historical and contemporary interest in the cases of the U.S. and Japanese economies. It is shown that higher average levels and moderate average maturities of debt can induce macroeconomic instability under a range of policies specified as simple rules. However, interest rate pegs in combination with active fiscal policies almost always ensure macroeconomic stability. This finding suggests that in periods where the zero lower bound on nominal interest rates is a relevant constraint on policy design, a switch in fiscal regime is desirable.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 515.

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Date of creation: 2011
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Handle: RePEc:fip:fednsr:515

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Keywords: Monetary policy ; Debts; Public ; Fiscal policy ; Interest rates ; Price levels;

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  1. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  2. Honkapohja, Seppo & Evans, George W., 2000. "Expectations and the stability problem for optimal monetary policies," Discussion Paper Series 1: Economic Studies 2000,10, Deutsche Bundesbank, Research Centre.
  3. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.
  4. George W. Evans & Seppo Honkapohja, 2002. "Policy Interaction, Learning and the Fiscal Theory of Prices," University of Oregon Economics Department Working Papers 2002-17, University of Oregon Economics Department, revised 07 Jun 2007.
  5. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  6. 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.
  7. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  8. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  9. Bruce Preston & Stefano Eusepi, 2011. "The maturity structure of debt, monetary policy and expectations stabilization," 2011 Meeting Papers 1287, Society for Economic Dynamics.
  10. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
  11. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  12. Troy Davig & Eric M. Leeper, 2007. "Fluctuating Macro Policies and the Fiscal Theory," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 247-316 National Bureau of Economic Research, Inc.
  13. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-22, December.
  14. 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.
  15. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  16. Robert E. Hall, 2009. "Reconciling Cyclical Movements in the Marginal Value of Time and the Marginal Product of Labor," Journal of Political Economy, University of Chicago Press, vol. 117(2), pages 281-323, 04.
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Cited by:
  1. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  2. Josef Hollmayr & Christian Matthes, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Working Paper 13-15, Federal Reserve Bank of Richmond.

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