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Stepping on a Rake: the Fiscal Theory of Monetary Policy

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  • John H. Cochrane

Abstract

The fiscal theory of the price level can describe monetary policy. Governments can set interest rate targets and thereby affect inflation, with no change in fiscal surpluses. The same basic mechanism describes interest rate targets, forward guidance, open market operations, and quantitative easing. It does not require any monetary, pricing, or other frictions. In the presence of long-term debt, higher interest rates lead to temporarily lower inflation, a challenging sign. I derive and replicate the results of the Sims (2011) “stepping on a rake” model, which first produced this negative sign, and produces realistic impulse-response functions. I show that Sims' result is robust to many model features, but essentially requires long-term debt.

Suggested Citation

  • John H. Cochrane, 2016. "Stepping on a Rake: the Fiscal Theory of Monetary Policy," NBER Working Papers 22979, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:22979
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    References listed on IDEAS

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    1. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    2. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
    3. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
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    Cited by:

    1. Bai, Yuting & Leeper, Eric M., 2017. "Fiscal stabilization vs. passivity," Economics Letters, Elsevier, vol. 154(C), pages 105-108.
    2. Jalal Qanas & Malcom Sawyer, 2019. "Macroeconomics and natural rates: some reflections on Pasinetti’s fair rate of interest," Bulletin of Political Economy, Bulletin of Political Economy, vol. 13(2), pages 189-208, December.

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    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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    1. Stepping on a Rake: Replication and Diagnosis (NBER 2016) in ReplicationWiki

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