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Price Level Determinacy and Monetary Policy under a Balanced-Budget Requirement

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Author Info
Stephanie Schmitt-Grohe () (Rutgers University)
Martin Uribe () (University of Pennsylvania)

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Abstract

This paper analyzes the implications of a balanced-budget fiscal policy rule for price-level determination in a cash-in-advance economy under three alternative monetary policy regimes. It shows that the price level is indeterminate under a nominal interest rate peg and determinate under a money growth rate peg. Under a feedback rule that sets the nominal interest rate as a non-negative and non-decreasing function of the inflation rate, the price level is indeterminate for both low and high values of the inflation elasticity of the feedback rule and determinate for intermediate values. We also study balanced-budget rules that allow for bounded secondary surpluses or deficits. Comparing our results to those emphasized in the fiscal theory of the price level, it becomes clear that a key consideration for price-level determination is whether fiscal policy is specified as an exogenous sequence of primary surpluses/deficits or, alternatively, as an exogenous sequence of secondary surpluses/deficits.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 199833.

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Date of creation: 09 Nov 1998
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Handle: RePEc:rut:rutres:199833

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Related research
Keywords: balanced-budget rules; fiscal theory of the price level; monetary policy;

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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
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization

References listed on IDEAS
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  1. 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.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 1995. "Balanced-budget rules, distortionary taxes, and aggregate instability," Finance and Economics Discussion Series 95-44, Board of Governors of the Federal Reserve System (U.S.).
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  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. [Downloadable!] (restricted)
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  4. 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)
  5. 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. [Downloadable!] (restricted)
  6. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  7. Lucas, Robert E, Jr & Stokey, Nancy L, 1987. "Money and Interest in a Cash-in-Advance Economy," Econometrica, Econometric Society, vol. 55(3), pages 491-513, May. [Downloadable!] (restricted)
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