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Price level determinacy and monetary policy under a balanced-budget requirement

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  • Schmitt-Grohe, Stephanie
  • Uribe, Martin

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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  • Schmitt-Grohe, Stephanie & Uribe, Martin, 2000. "Price level determinacy and monetary policy under a balanced-budget requirement," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 211-246, February.
  • Handle: RePEc:eee:moneco:v:45:y:2000:i:1:p:211-246
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    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; Treasury Policy

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