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A Demand Theory of the Price Level

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  • Marcus Hagedorn

    (Universitetet i Oslo)

Abstract

In this paper I propose a theory of a globally unique price level based on the simple idea that the price equates demand with supply in the goods market. Monetary policy through setting nominal interest rates, e.g. an interest rate peg, and fiscal policy, which satisfies the present value budget constraint at all times, jointly determine the price level. In contrast to the conventional view the long run inflation rate is, in the absence of output growth, equal to the growth rate of nominal government spending which is controlled by fiscal policy. This new theory where nominal government spending anchors aggregate demand and therefore current and future prices suggests a different perspective on the fiscal and monetary transmission mechanism, on policy coordination, on policies at the zero-lower bound and on U.S. inflation history.

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  • Marcus Hagedorn, 2016. "A Demand Theory of the Price Level," 2016 Meeting Papers 941, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:941
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    References listed on IDEAS

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    1. Orazio P. Attanasio & Nicola Pavoni, 2011. "Risk Sharing in Private Information Models With Asset Accumulation: Explaining the Excess Smoothness of Consumption," Econometrica, Econometric Society, vol. 79(4), pages 1027-1068, July.
    2. Greg Kaplan & Giovanni L. Violante, 2014. "A Model of the Consumption Response to Fiscal Stimulus Payments," Econometrica, Econometric Society, vol. 82(4), pages 1199-1239, July.
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    Cited by:

    1. Suha Alawi, 2019. "The Effect of Direct Foreign Investment on Stock Price Volatility in the Saudi Market," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 9(8), pages 875-887, August.
    2. Hagedorn, Marcus & Luo, Jinfeng & Manovskii, Iourii & Mitman, Kurt, 2019. "Forward guidance," Journal of Monetary Economics, Elsevier, vol. 102(C), pages 1-23.
    3. Kurt Mitman & Iourii Manovskii & Marcus Hagedorn, 2017. "The Fiscal Multiplier," 2017 Meeting Papers 1383, Society for Economic Dynamics.
    4. Kopiec, Paweł, 2020. "Employment prospects and the propagation of fiscal stimulus," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).

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