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The Fiscal Theory of Price Level with a Bubble

Author

Listed:
  • Markus K. Brunnermeier
  • Sebastian A. Merkel
  • Yuliy Sannikov

Abstract

This paper incorporates a bubble term in the standard Fiscal Theory of the Price Level equation to explain why countries with persistently negative primary surpluses can have a positively valued currency and low inflation. It also provides two illustrative models with closed-form solutions in which the return on government bonds is below the economy’s growth rate. The government can “mine” the bubble by perpetually rolling over its debt. Despite the bubble, the price level remains determined provided government policy credibly promises primary surpluses off-equilibrium. Sufficient “fiscal space” ensures that the bubble term is attached to government bonds rather than other assets, like crypto assets. The analysis provides a new perspective on debt sustainability analysis.

Suggested Citation

  • Markus K. Brunnermeier & Sebastian A. Merkel & Yuliy Sannikov, 2020. "The Fiscal Theory of Price Level with a Bubble," NBER Working Papers 27116, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27116
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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