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Policy interaction, learning and the fiscal theory of prices

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  • Evans , George W.

    (University of Oregon)

  • Honkapohja, Seppo

    (Bank of Finland, University of Helsinki)

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 rational expectations equilibria (REE). Our first result is that the fiscalist REE in the model of McCallum (2001) is not locally stable under learning. By contrast, in the setting of Leeper (1991), different possibilities can obtain. 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, the monetarist solution is the stable equilibrium.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0218.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 18/2002.

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Length: 32 pages
Date of creation: 28 Aug 2002
Date of revision:
Handle: RePEc:hhs:bofrdp:2002_018

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Keywords: inflation; expectations; fiscal and monetary policy; explosive price paths;

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References

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  1. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Timing and real indeterminacy in monetary models," Working Paper 9910R, Federal Reserve Bank of Cleveland.
  2. Evans, George W. & Ramey, Garey, 1998. "Calculation, Adaptation And Rational Expectations," Macroeconomic Dynamics, Cambridge University Press, vol. 2(02), pages 156-182, June.
  3. Bennett T. McCallum, 1998. "Indeterminacy, Bubbles, and the Fiscal Theory of Price Level Determination," NBER Working Papers 6456, National Bureau of Economic Research, Inc.
  4. 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.
  5. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589833.
  6. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
  7. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589826.
  8. Kreps,David M. & Wallis,Kenneth F. (ed.), 1997. "Advances in Economics and Econometrics: Theory and Applications," Cambridge Books, Cambridge University Press, number 9780521589819.
  9. repec:cup:macdyn:v:2:y:1998:i:2:p:156-82 is not listed on IDEAS
  10. 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.
  11. 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.
  12. 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.
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