Abstract
A central equation for the fiscal theory of the price level (FTPL) is the government budget constraint (or “government valuation equation”), which equates the real value of government debt to the present value of fiscal surpluses. In the past decade, the governments of most developed economies have paid very low interest rates, and there are many other periods in the past in which this has been the case. In this paper, we revisit the implications of the FTPL in a world where the rate of return on government debt may be below the growth rate of the economy, considering different sources for the low returns: dynamic inefficiency, the liquidity premium of government debt, or its favorable risk profile.This article is part of a Special Issue entitled ``Fiscal and Monetary Policies''.
Highlights
Models of monetary economies are plagued by the presence of multiple equilibria, which weakens the ability to make tight predictions.1 To select among them, it has become common to appeal to what Leeper [20] defined as “active monetary policies.” these rules imply local determinacy, but not global uniqueness, and are not universally accepted as an equilibrium selection criterion.2An alternative approach to price-level determinacy follows what Leeper [20] defined “active fiscal policies,” in which the requirement that government debt follows a stable trajectory is used to select an equilibrium
According to the fiscal theory of the price level (FTPL), price level determinacy follows when the present value of government surpluses does not react to the price level in a way that ensures government budget balance; rather, government debt is a promise to deliver “dollars”, and the value of a dollar adjusts in equilibrium so that the present value of surpluses and the real value of debt match
We show that the FTPL is no longer able to select a unique equilibrium, and multiple price levels are consistent with an equilibrium even when taxes are set in real terms and do not adjust
Summary
Models of monetary economies are plagued by the presence of multiple equilibria, which weakens the ability to make tight predictions. To select among them, it has become common to appeal to what Leeper [20] defined as “active monetary policies.” these rules imply local determinacy, but not global uniqueness, and are not universally accepted as an equilibrium selection criterion.. If the economy starts with positive values of government debt and sMAX + τ > 0, a continuum of initial levels of prices is consistent with an equilibrium, as described by equation (20); the same considerations about comparative statics and the presence of a lower bound for prices that we discussed in Section 4 apply here as well. All of these results are reminiscent of the properties of equilibria with moneysupply rules in cash-in-advance economies, as in Matsuyama [23, 24] or Woodford [32]. This is not surprising, since debt plays the same role as fiat money for this environment.
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