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A game-theoretic view of the fiscal theory of the price level

  • Marco Bassetto

The goal of this paper is to probe the validity of the fiscal theory of the price level by modeling explicitly the market structure in which households and the governments make their decisions. I describe the economy as a game, and I am thus able to state precisely the consequences of actions that are out of the equilibrium path. I show that there exist government strategies that lead to a version of the fiscal theory, in which the price level is determined by fiscal variables alone. However, these strategies are more complex than the simple budgetary rules usually associated with the fiscal theory, and the government budget constraint cannot be merely viewed as an equilibrium condition.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 612.

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Date of creation: 2001
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Publication status: Published in Econometrica> (Vol. 70, No. 6, November 2002, pp. 2167-2195)
Handle: RePEc:fip:fedmwp:612
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  1. V. V. Chari & Patrick J Kehoe, 1998. "Sustainable Plans," Levine's Working Paper Archive 600, David K. Levine.
  2. Pesendorfer, Wolfgang & Levine, David & Fudenberg, Drew, 1998. "When Are Nonanonymous Players Negligible?," Scholarly Articles 3203775, Harvard University Department of Economics.
  3. W.H. Buiter, 2000. "The Fallacy of the Fiscal Theory of the Price Level," CEP Discussion Papers dp0447, Centre for Economic Performance, LSE.
  4. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  5. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the fiscal theory of the price level," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-38.
  6. Levine, David K & Pesendorfer, Wolfgang, 1995. "When Are Agents Negligible?," American Economic Review, American Economic Association, vol. 85(5), pages 1160-70, December.
  7. Bassetto, Marco, 2005. "Equilibrium and government commitment," Journal of Economic Theory, Elsevier, vol. 124(1), pages 79-105, September.
  8. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," CRSP working papers 478, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  9. Cochrane, John H., 2005. "Money as stock," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 501-528, April.
  10. Arial Rubinstein & Asher Wolinsky, 1985. "Equilibrium in a Market with Sequential Bargaining," Levine's Working Paper Archive 623, David K. Levine.
  11. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc.
  12. Woodford, M., 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Papers 632, Stockholm - International Economic Studies.
  13. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
  14. 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.
  15. 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.
  16. Gale, Douglas M, 1986. "Bargaining and Competition Part I: Characterization," Econometrica, Econometric Society, vol. 54(4), pages 785-806, July.
  17. 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.
  18. 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.
  19. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
  20. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  21. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  22. Gale, Douglas M, 1986. "Bargaining and Competition Part II: Existence," Econometrica, Econometric Society, vol. 54(4), pages 807-18, July.
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