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Policy Interaction, Learning, And The Fiscal Theory Of Prices

  • EVANS, GEORGE W.
  • HONKAPOHJA, SEPPO

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.

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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 11 (2007)
Issue (Month): 05 (November)
Pages: 665-690

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Handle: RePEc:cup:macdyn:v:11:y:2007:i:05:p:665-690_06
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  1. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  2. 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.
  3. repec:cup:cbooks:9780521589833 is not listed on IDEAS
  4. repec:cup:macdyn:v:2:y:1998:i:2:p:156-82 is not listed on IDEAS
  5. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
  6. Buiter, Willem H., 1998. "The Young Person's Guide to Neutrality, Price Level Indeterminacy, Interest Rate Pegs and Fiscal Theories of the Price Level," CEPR Discussion Papers 1799, C.E.P.R. Discussion Papers.
  7. Bennett T. McCallum, 1998. "Indeterminacy, Bubbles, and the Fiscal Theory of Price Level Determination," NBER Working Papers 6456, National Bureau of Economic Research, Inc.
  8. repec:cup:cbooks:9780521589819 is not listed on IDEAS
  9. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  10. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  11. repec:cup:cbooks:9780521589826 is not listed on IDEAS
  12. Evans, George W. & Ramey, Garey, 1998. "Calculation, Adaptation And Rational Expectations," Macroeconomic Dynamics, Cambridge University Press, vol. 2(02), pages 156-182, June.
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