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Money as Stock: Price Level Determination with no Money Demand

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  • John H. Cochrane

Abstract

I show that a determinate, finite price level can be achieved in an economy with no monetary frictions, and no commodity standard or other explicit redemption commitment. I make one small modification to a standard cash in advance model: I reopen the security market at the end of the day. With this modification, overnight money demand is precisely zero. I show that the price level is still determined, however, by the government debt valuation equation. Nominal government debt is, despite appearances, a residual claim to government surpluses. Thus, the price level is determined just like the price of stock, and just as if we used (say) Microsoft stock as numeraire, unit of account, and medium of exchange. I resolve Buiter's (1999) criticism that fiscal price level determination mis-treats the government budget constraint. The government is not forced by a budget constraint to raise surpluses in response to an off-equilibrium deflation, just as Microsoft is not forced to raise earnings if there is a bubble in its stock price. I also address McCallum's (1998) criticism that fiscal models do not properly treat indeterminacies, and a number of other confusions and misconceptions surrounding fiscal price level determination. I provide a taxonomy of fiscal and monetary regimes.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7498.

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Date of creation: Jan 2000
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Handle: RePEc:nbr:nberwo:7498

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  1. 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.
  2. Sargent, Thomas J & Velde, Francois R, 1995. "Macroeconomic Features of the French Revolution," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 474-518, June.
  3. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  4. Rao Aiyagari, S. & Gertler, Mark, 1985. "The backing of government bonds and monetarism," Journal of Monetary Economics, Elsevier, vol. 16(1), pages 19-44, July.
  5. Narayana Kocherlakota & Christopher Phelan, 1999. "Explaining the fiscal theory of the price level," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-23.
  6. Benjamin M. Friedman, 1999. "The Future of Monetary Policy: The Central Bank as an Army With Only a Signal Corps," NBER Working Papers 7420, National Bureau of Economic Research, Inc.
  7. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  8. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
  9. Friedman, Benjamin M, 1999. "The Future of Monetary Policy: The Central Bank as an Army with Only a Signal Corps?," International Finance, Wiley Blackwell, vol. 2(3), pages 321-38, November.
  10. Heidi Willmann Richards, 1995. "Daylight overdraft fees and the Federal Reserve's payment system risk policy," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Dec, pages 1065-1077.
  11. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  12. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  13. 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.
  14. Lucas, Robert E, Jr, 1980. "Equilibrium in a Pure Currency Economy," Economic Inquiry, Western Economic Association International, vol. 18(2), pages 203-20, April.
  15. Lucas, Robert E., 1984. "Money in a theory of finance," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 21(1), pages 9-46, January.
  16. Starr, Ross M, 1974. "The Price of Money in a Pure Exchange Monetary Economy with Taxation," Econometrica, Econometric Society, vol. 42(1), pages 45-54, January.
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