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Monetary and fiscal theories of the price level: the irreconcilable differences

  • Bennett T. McCallum
  • Edward Nelson

The fiscal theory of the price level (FTPL) has attracted much attention but disagreement remains concerning its defining characteristics. Some writers have emphasized implications regarding interest-rate pegging and determinacy of RE solutions, whereas others have stressed its capacity to generate equilibria in which price level trajectories mimic those of bonds and differ drastically from those of money supplies. We argue that the FTPL attained prominence precisely because it appeared to provide a theory whose implications differ greatly from conventional monetary analysis; accordingly we review monetarist writings to identify the primary distinctions. In addition, we review recent findings concerning learnability - and therefore plausibility - of competing RE equilibria. These indicate that when FTPL and monetarist equilibria differ, the latter are more plausible in the vast majority of cases. Under Ricardian assumptions, necessary for clear distinctions, theoretical analysis indicates that fiscal and monetary coordination is not necessary for macroeconomic stability.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2006-010.

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Date of creation: 2006
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Publication status: Published in Oxford Review of Economic Policy, Winter 2005, 21(4), pp. 565-83
Handle: RePEc:fip:fedlwp:2006-010
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  1. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  2. 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.
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  7. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
  8. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  9. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  10. Paul W. McCracken, 1950. "The Present Status Of Monetary And Fiscal Policy," Journal of Finance, American Finance Association, vol. 5(1), pages 24-48, 03.
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  12. Woodford, Michael, 2003. "Comment on: Multiple-solution indeterminacies in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1177-1188, July.
  13. Óscar J. Arce, 2005. "The fiscal theory of the price level: a narrow theory for non-fiat money," Banco de Espa�a Working Papers 0501, Banco de Espa�a.
  14. 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.
  15. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  16. Dirk Niepelt, 2004. "The Fiscal Myth of the Price Level," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 276-299, February.
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  19. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  20. Narayana Kocherlakota & Christopher Phelan, 1999. "Explaining the fiscal theory of the price level," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-23.
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