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Policy Interaction, Learning and the Fiscal Theory of Prices

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 the rational expectations equilibria (REE). Our first result is that the fiscalist REE in the model of McCallum (2001) is not locally stable under learning. In contrast, in the setting of Leeper (1991), different possibilities can arise. 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, however, the monetarist solution is instead the stable equilibrium.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3564.

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Date of creation: Oct 2002
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Handle: RePEc:cpr:ceprdp:3564
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  1. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Timing and real indeterminacy in monetary models," Working Paper 9910R, Federal Reserve Bank of Cleveland.
  2. Bennett T. McCallum, . "Indeterminacy, Bubbles, and the Fiscal Theory of Price Level Determination," GSIA Working Papers 1998-19, Carnegie Mellon University, Tepper School of Business.
  3. repec:cup:cbooks:9780521589826 is not listed on IDEAS
  4. Willem H. Buiter, 1998. "The Young Person's Guide to Neutrality, Price Level Indeterminacy, Interest Rate Pegs, and Fiscal Theories of the Price Level," NBER Working Papers 6396, National Bureau of Economic Research, Inc.
  5. repec:cup:cbooks:9780521589833 is not listed on IDEAS
  6. repec:cup:cbooks:9780521589819 is not listed on IDEAS
  7. 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.
  8. 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.
  9. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
  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:macdyn:v:2:y:1998:i:2:p:156-82 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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