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Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level

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  • JOHN H. COCHRANE

Abstract

The fiscal theory says that the price level is determined by the ratio of nominal debt to the present value of real primary surpluses. The maturity structure of the debt matters in this theory. For example, it determines whether news of future deficits implies current inflation or future inflation, and the long-term debt allows the government to offset surplus shocks by ex-post devaluation. In the optimal policy, the government uses fiscal operations to smooth cyclical fiscal shocks. Since policy movements react to events rather than cause them, the optimal policy produces time series that are similar to U.S. time series.
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Suggested Citation

  • John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," CRSP working papers 478, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    • Handle: RePEc:wop:chispw:478
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    File URL: http://gsbwww.uchicago.edu/fac/finance/papers/fiscal_theory.pdf
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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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