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Policy interaction, learning and the fiscal theory of prices

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  • Evans, George W.
  • Honkapohja, Seppo

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.

Suggested Citation

  • Evans, George W. & Honkapohja, Seppo, 2002. "Policy interaction, learning and the fiscal theory of prices," Bank of Finland Research Discussion Papers 18/2002, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2002_018
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    Keywords

    inflation; expectations; fiscal and monetary policy; explosive price paths;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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