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Monetary-Fiscal Policy Interactions and the Price Level: Background and Beyond

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Author Info
Eric M. Leeper
Tack Yun

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Abstract

The paper presents the fiscal theory of the price level in a variety of models, including endowment economies with lump-sum taxes and production economies with proportional income taxes. We offer a microeconomic perspective on the fiscal theory by computing a Slutsky-Hicks decomposition of the effects of tax changes into substitution, wealth, and revaluation effects. Revaluation effects arise whenever tax changes alter the value of outstanding nominal government liabilities by changing the price level. Under certain assumptions on monetary and fiscal behavior, the revaluation effect reflects the fiscal theory mechanism. When taxes distort, two Laffer curves arise, implying that a tax increase can lower or raise the price level and the revaluation effect can be positive or negative, depending on which side of a particular Laffer curve the economy resides.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11646.

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Date of creation: Oct 2005
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Handle: RePEc:nbr:nberwo:11646

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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References listed on IDEAS
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  1. Elmendorf, Douglas W. & Gregory Mankiw, N., 1999. "Government debt," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 25, pages 1615-1669 Elsevier. [Downloadable!] (restricted)
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  2. Willem H. Buiter, 2002. "The Fiscal Theory Of The Price Level: A Critique," Economic Journal, Royal Economic Society, vol. 112(481), pages 459-480, July. [Downloadable!] (restricted)
  3. Gauti Eggertsson & Michael Woodford, 2004. "Optimal monetary and fiscal policy in a liquidity trap," Discussion Papers 0405-02, Columbia University, Department of Economics. [Downloadable!]
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  4. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
    Other versions:
  5. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December. [Downloadable!] (restricted)
  6. 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.
  7. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun. [Downloadable!]
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  8. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  9. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June. [Downloadable!] (restricted)
  11. Eric M. Leeper, 1993. "The policy tango: toward a holistic view of monetary and fiscal effects," Economic Review, Federal Reserve Bank of Atlanta, issue Jul, pages 1-27.
  12. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February. [Downloadable!] (restricted)
  13. Eric M. Leeper, 2003. "Fiscal Policy and Inflation: Pondering the Imponderables," NBER Working Papers 9506, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  14. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  15. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July. [Downloadable!] (restricted)
  16. P. Benigno & M. Woodford, 2003. "Optimal monetary and fiscal policy: a linear-quadratic approach," Proceedings, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Panagiotis Chronis & Aspassia Strantzalou, 2008. "Monetary and Fiscal Policy Interaction: What is the Role of the Transaction Cost of the Tax System in Stabilisation Policies?," Working Papers 71, Bank of Greece. [Downloadable!]
  2. Mathias Trabandt & Harald Uhlig, 2006. "How Far Are We From The Slippery Slope? The Laffer Curve Revisited," SFB 649 Discussion Papers SFB649DP2006-023, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
    Other versions:
  3. Andreas Schabert & Leopold von Thadden, 2006. "Distortionary taxation, debt, and the price level," Working Paper Series 577, European Central Bank. [Downloadable!]
    Other versions:
  4. Piergallini, Alessandro & Rodano, Giorgio, 2009. "Public Debt, Distortionary Taxation, and Monetary Policy," MPRA Paper 15348, University Library of Munich, Germany. [Downloadable!]
  5. Óscar J. Arce, 2005. "Reflections on fiscalist divergent price-paths," Banco de España Working Papers 0533, Banco de España. [Downloadable!]
  6. Luciano Greco, 2008. "A Note on Social Security and Public Debt," "Marco Fanno" Working Papers 0083, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
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