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Policy Rules Under the Monetary and the Fiscal Theories of the Price-Level

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  • Jagjit S. Chadha

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Abstract

Price-level determination requires co-ordination of monetary and fiscal policy to ensure a unique rational expectations equilibrium (REE). This paper derives a number of implications for simple interest rate rules resulting from various fiscal strategies. We show that fiscal choices under either the monetary theory of the price-level (MTPL) and the fiscal theory of the price-level (FTPL) can challenge widely accepted principles of monetary policy. Specifically, we show that a fiscal rule that responds aggressively to output and inflation may force the monetary authorities to adopt significantly more aggressive output and inflation stabilization policy than suggested by the the Taylor Principle. We also show how when monetary policy is severely constrained, the fiscal policy maker can act to stabilise the economy. Some policy conclusions in light of the lower zero bound for monetary policy and debt stabilization are drawn.

Suggested Citation

  • Jagjit S. Chadha, 2010. "Policy Rules Under the Monetary and the Fiscal Theories of the Price-Level," Studies in Economics 1013, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:1013
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    Cited by:

    1. Jagjit S. Chadha & Luisa Corrado, 2006. "On the Determinacy of Monetary Policy under Expectational Errors," CDMA Working Paper Series 200603, Centre for Dynamic Macroeconomic Analysis, revised 15 Apr 2007.

    More about this item

    Keywords

    Monetary and Fiscal Policy Rules; Ricardian; Non-Ricardian Fiscal Policy;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • 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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