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Learning the fiscal theory of the price level: Some consequences of debt-management policy

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  • Eusepi, Stefano
  • Preston, Bruce

Abstract

This paper examines the consequences of the scale and composition of the public debt in policy regimes in which monetary policy is ‘passive’ and fiscal policy ‘active’. This configuration of policy is argued to be of both historical and contemporary interest, in economies such as the US and Japan. It is shown that higher average levels and moderate average maturities of debt can induce macroeconomic instability for a range of policies specified as simple rules. However, interest-rate pegs combined with active fiscal policies almost always ensure macroeconomic stability. This suggests that in periods where the zero lower bound on nominal interest rates is a relevant constraint on policy design, a switch in fiscal regime is desirable.

Suggested Citation

  • Eusepi, Stefano & Preston, Bruce, 2011. "Learning the fiscal theory of the price level: Some consequences of debt-management policy," Journal of the Japanese and International Economies, Elsevier, vol. 25(4), pages 358-379.
  • Handle: RePEc:eee:jjieco:v:25:y:2011:i:4:p:358-379 DOI: 10.1016/j.jjie.2011.09.003
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    References listed on IDEAS

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    1. Evans, George W. & Honkapohja, Seppo, 2007. "Policy Interaction, Learning, And The Fiscal Theory Of Prices," Macroeconomic Dynamics, Cambridge University Press, pages 665-690.
    2. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
    3. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," FRB Atlanta Working Paper 2003-18, Federal Reserve Bank of Atlanta.
    4. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-1322, December.
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    8. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, pages 1105-1129.
    9. Evans, George W. & Honkapohja, Seppo, 2007. "Policy Interaction, Learning, And The Fiscal Theory Of Prices," Macroeconomic Dynamics, Cambridge University Press, pages 665-690.
    10. Troy Davig & Eric M. Leeper, 2007. "Fluctuating Macro Policies and the Fiscal Theory," NBER Chapters,in: NBER Macroeconomics Annual 2006, Volume 21, pages 247-316 National Bureau of Economic Research, Inc.
    11. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, pages 1105-1129.
    12. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, pages 129-147.
    13. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.
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    15. Francesco Bianchi, 2013. "Regime Switches, Agents' Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 463-490.
    16. Stefano Eusepi & Bruce Preston, 2010. "Central Bank Communication and Expectations Stabilization," American Economic Journal: Macroeconomics, American Economic Association, pages 235-271.
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    19. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, pages 345-370.
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    Citations

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    Cited by:

    1. Eric M. Leeper & Todd B. Walker, 2012. "Perceptions and Misperceptions of Fiscal Inflation," NBER Chapters,in: Fiscal Policy after the Financial Crisis, pages 255-299 National Bureau of Economic Research, Inc.
    2. Dominguez, Begona & Gomis-Porqueras, Pedro, 2016. "The Effects of Secondary Markets for Government Bonds on Inflation Dynamics," MPRA Paper 82448, University Library of Munich, Germany.
    3. Josef Hollmayr & Christian Matthes, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Working Paper 13-15, Federal Reserve Bank of Richmond.
    4. de Mendonça, Helder Ferreira & Nicolay, Rodolfo Tomás da Fonseca, 2017. "Is communication clarity from fiscal authority useful? Evidence from an emerging economy," Journal of Policy Modeling, Elsevier, pages 35-51.
    5. Eric M. Leeper, 2013. "Fiscal Limits and Monetary Policy," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 13(2), pages 33-58.
    6. Hollmayr, Josef & Matthes, Christian, 2015. "Learning about fiscal policy and the effects of policy uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 59(C), pages 142-162.
    7. Dominguez, Begona & Gomis-Porqueras, Pedro, 2016. "The Effects of Secondary Markets and Unsecured Credit on Inflation Dynamics," MPRA Paper 75096, University Library of Munich, Germany.

    More about this item

    Keywords

    Debt management policy; Maturity structure; Monetary policy; Expectations stabilization;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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