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Is the Price Level Determined by the Needs of Fiscal Solvency?

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Author Info
Matthew B. Canzoneri
Robert E. Cumby
Behzad T. Diba

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Abstract

A new theory of price determination suggests that if primary surpluses are independent of the level of debt, the price level has to jump' to assure fiscal solvency. In this regime (which we call Fiscal Dominant), monetary policy has to work through seignorage to control the price level. If on the other hand primary surpluses are expected to respond to the level of debt in a way that assures fiscal solvency (a regime we call Money Dominant), then the price level is determined in more conventional ways. In this paper we develop testable restrictions that differentiate between the two regimes. Using post war data, we present what we think is overwhelming evidence that the United States is in a Money Dominant regime; even the post Reagan data (1980 to 1995) seem to support that contention.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6471.

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Date of creation: Mar 1998
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Handle: RePEc:nbr:nberwo:6471

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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  1. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," CRSP working papers 479, Center for Research in Security Prices, Graduate School of Business, University of Chicago. [Downloadable!]
    Other versions:
  2. 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.
  3. Paul R. Masson, 1987. "The Dynamics of a Two-Country Minimodel under Rational Expectations," Annales d'Economie et de Statistique, ADRES, issue 6-7, pages 03, Avril-Sep. [Downloadable!]
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  5. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998. "Monetary Policy Shocks: What Have We Learned and to What End?," NBER Working Papers 6400, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the fiscal theory of the price level," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-38. [Downloadable!]
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  8. Canzoneri, Matthew B & Diba, Behzad, 1996. "Fiscal Constraints on Central Bank Independence and Price Stability," CEPR Discussion Papers 1463, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  9. Shaghil Ahmed & John H. Rogers, 1995. "Government budget deficits and trade deficits: are present value constraints satisfied in long-term data?," International Finance Discussion Papers 494, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  10. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  11. Stephanie Schmitt-Grohe & Martin Uribe, 1998. "Price Level Determinacy and Monetary Policy under a Balanced-Budget Requirement," Departmental Working Papers 199833, Rutgers University, Department of Economics. [Downloadable!]
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  12. Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May. [Downloadable!] (restricted)
  13. James D. Hamilton & Marjorie A. Flavin, 1985. "On the Limitations of Government Borrowing: A Framework for Empirical Testing," NBER Working Papers 1632, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867-1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1.
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  17. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  18. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Fiscal Discipline and Exchange Rate Regimes," CEPR Discussion Papers 1899, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  19. F. Brayton & P. Tinsley, 1996. "A guide to FRB/US: a macroeconomic model of the United States," Finance and Economics Discussion Series 96-42, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  20. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  21. Henning Bohn, 1998. "The Behavior Of U.S. Public Debt And Deficits," The Quarterly Journal of Economics, MIT Press, vol. 113(3), pages 949-963, August. [Downloadable!] (restricted)
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