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Is the Price Level Determined by the Needs of Fiscal Solvency?

  • Canzoneri, Matthew B
  • Cumby, Robert
  • Diba, Behzad

A new theory of price determination suggests that if primary surpluses are independent of the level of debt, the price level has to ‘jump’ to assure fiscal solvency. In this regime (which we call fiscal dominant), monetary policy has to work through seignorage to control the price level. If, on the other hand, primary surpluses are expected to respond to the level of debt in a way that assures fiscal solvency (a regime we call money dominant), then the price level is determined in more conventional ways. This paper develops testable restrictions that differentiate between the two regimes. Using post-war data, the paper presents what we think is overwhelming evidence that the United States is in a money dominant regime; even the post-Reagan data (1980–95) seem to support that contention.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1772.

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Date of creation: Jan 1998
Date of revision:
Handle: RePEc:cpr:ceprdp:1772
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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
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  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. Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May.
  8. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," CRSP working papers 479, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  9. 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.
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  11. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  12. Bergin, Paul R., 2000. "Fiscal solvency and price level determination in a monetary union," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 37-53, February.
  13. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.).
  14. Shaghil Ahmed & John H. Rogers, 1995. "Government budget deficits and trade deficits: are present value constraints satisfied in long-term data?," International Finance Discussion Papers 494, Board of Governors of the Federal Reserve System (U.S.).
  15. Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867–1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1, December.
  16. Stephanie Schmitt-Grohe & Martin Uribe, 1997. "Price level determinacy and monetary policy under a balanced-budget requirement," Finance and Economics Discussion Series 1997-17, Board of Governors of the Federal Reserve System (U.S.).
  17. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the Fiscal Theory of the Price Level," NBER Working Papers 7668, National Bureau of Economic Research, Inc.
  18. Henning Bohn, . "Budget Balance Through Revenue or Spending Adjustments ? Some Historical Evidence for the United States (Reprint 013)," Rodney L. White Center for Financial Research Working Papers 03-91, Wharton School Rodney L. White Center for Financial Research.
  19. 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.
  20. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Fiscal Discipline and Exchange Rate Regimes," CEPR Discussion Papers 1899, C.E.P.R. Discussion Papers.
  21. Bohn, H., 1991. "Budget Balance Through Revenue or Spending Adjustments? Some Historical Evidence for the United States," Weiss Center Working Papers 3-91, Wharton School - Weiss Center for International Financial Research.
  22. 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.
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  24. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
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