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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 %u2013 and therefore plausibility %u2013 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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12089.

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Date of creation: Mar 2006
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Publication status: published as Bennett T. McCallum & Edward Nelson, 2005. "Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences," Oxford Review of Economic Policy, Oxford University Press, vol. 21(4), pages 565-583, Winter.
Handle: RePEc:nbr:nberwo:12089
Note: EFG ME
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  1. Willem H. Buiter, 2002. "The Fiscal Theory Of The Price Level: A Critique," Economic Journal, Royal Economic Society, vol. 112(481), pages 459-480, July.
  2. David B. Gordon & Eric M. Leeper, 2002. "The Price Level, the Quantity Theory of Money, and the Fiscal Theory of the Price Level," NBER Working Papers 9084, National Bureau of Economic Research, Inc.
  3. 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.
  4. Niepelt, Dirk, 2002. "The Fiscal Myth of the Price Level," Seminar Papers 710, Stockholm University, Institute for International Economic Studies.
  5. 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.
  6. 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.
  7. Bennett T. McCallum, . "Is The Fiscal Theory of the Price Level Learnable?," GSIA Working Papers 2003-24, Carnegie Mellon University, Tepper School of Business.
  8. George W. Evans & Seppo Honkapohja, 2002. "Policy Interaction, Learning and the Fiscal Theory of Prices," University of Oregon Economics Department Working Papers 2002-17, University of Oregon Economics Department, revised 07 Jun 2007.
  9. McCallum, Bennett T., 2001. "Indeterminacy, bubbles, and the fiscal theory of price level determination," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 19-30, February.
  10. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  11. 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.
  12. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  13. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  14. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
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  19. Cochrane, John H., 2005. "Money as stock," Journal of Monetary Economics, Elsevier, vol. 52(3), pages 501-528, April.
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  21. Milton Friedman, 1971. "A Theoretical Framework for Monetary Analysis," NBER Books, National Bureau of Economic Research, Inc, number frie71-1, October.
  22. 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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  24. Bennett T. McCallum, 2003. "Multiple-Solution Indeterminacies in Monetary Policy Analysis," NBER Working Papers 9837, National Bureau of Economic Research, Inc.
  25. Woodford, Michael, 2003. "Comment on: Multiple-solution indeterminacies in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1177-1188, July.
  26. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "The fiscal theory of the price level," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 22-32.
  27. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
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