Fiscal Theory Of The Price Level Research Articles

Generalizing Determinacy under Monetary and Fiscal Policy Switches: The Case of the Zero Lower Bound

AbstractIn a fixed‐regime context, it has been established since the work of Leeper (1991) that a determinate and unique equilibrium can be achieved under both monetary dominance (characterized by an active monetary policy and a passive fiscal policy) and fiscal dominance (characterized by an active fiscal policy and a passive monetary policy) regimes yield a determinate unique equilibrium. In this paper, we generalize this well‐established policy‐mix taxonomy to regime‐switching models, and show that switches from monetary dominance to fiscal dominance regimes (and vice versa) render the economy indeterminate for standard parameter values. We apply our results to the important case of the exit from the zero lower bound (ZLB), where monetary policy is inherently passive. Contrary to the fixed‐regime prediction, the economy switching between the ZLB in a fiscally led regime and a monetary dominance regime is robustly indeterminate, making the coordination of agents' beliefs hard for anchoring expected inflation. Finally, we propose a direction toward which the perspective of the fiscal theory of the price level can be made consistent with a unique stable equilibrium.

Safeguarding economic stability: the interplay of fiscal dominance and monetary policy in South Africa

PurposeThe purpose of this study is to investigate the interplay between fiscal dominance and monetary policy in South Africa from 1960 to 2023.Design/methodology/approachThe study employs a structural vector autoregression (SVAR) medel to analyze the relationship between fiscal dominance and monetary policy. Short-term and long-term shocks of government borrowing and deficits are examined to understand their impact on inflation dynamics.FindingsFiscal dominance has a significant effect both in the short and long run. There is evidence that government debt and deficits increase inflation, overriding the effects of monetary policy aimed at maintaining price stability. On the other hand, the study reveals that money supply shocks have a greater effect in reducing fiscal dominance compared to interest rate shocks. The variance movement on inflation is significantly explained by government debt and deficits. This emphasizes the persistence of inflationary pressures associated with fiscal dominance, highlighting the importance of effective policy interventions to mitigate inflationary risks.Originality/valueThis study contributes to the existing literature by providing insights into the dynamics of fiscal dominance in South Africa. Moreover, this study extends the theoretical framework of the fiscal theory of the price level (FTPL) and the government budget constraint. This study contributes valuable insights into the dynamics of fiscal dominance in South Africa and offers guidance for policymakers in formulating strategies to safeguard economic stability.

Testing the Fiscal Theory of Price Level for Türkiye with Fourier-Based Empirical Approaches

Inflation is introduced as a monetary phenomenon in orthodox approaches. However, in the fiscal theory of the price level, the policies implemented by the fiscal authority, which determines the present value of intertemporal budget constraint independently of its liabilities, may be determinative of the price level. In this study, the validity of the fiscal theory of the price level for Türkiye was tested via the Fourier-ADL co-integration and Fourier Toda-Yamamoto causality approach. The findings indicate that fiscal policy was effective in determining the price level in the 1975-2021 period.

Investigating The Fiscal Theory of the Price Level (FTPL) in Nigeria: The Role of Private Sector Expectation

Investigating The Fiscal Theory of the Price Level (FTPL) in Nigeria: The Role of Private Sector Expectation

Revisiting speculative hyperinflations in monetary models: A rejoinder

In this note, we present a formal proof of Obstfeld and Rogoff's (1983, 2021) claim that their fractional-currency-backing scheme eliminates the inflationary equilibria in the money-in-utility model. To do so, we fully articulate the optimization problem of consumers who have the option to redeem (part or all of) their cash for a small amount of goods at any date. We also relate the scheme to the Fiscal Theory of the Price Level.

The fiscal theory of the price level: The case of Morocco

In this paper, we will use the econometric model and the price-level fiscal theory (PLFT), which looks at how the government surplus, debt, and inflation interact to apply a vector autoregression (VAR) model to the Moroccan economy. We first want to figure out how fiscal and monetary policy shocks affect the economy. The second thing we want to do is study how fiscal and monetary policy affects each other. So, the theoretical limits we used to determine our model are based on an FTPL framework. The general price level budget and Keynesian theories are not entirely wrong because of what we found. Also, the fact that most of the variation in inflation can be explained by changes in the money supply suggests that monetary policy works well in the Moroccan economy to control inflation. However, debt policy has little effect on this control. The government is worried about the level of public debt in Morocco because it positively affects the economy. Also, the positive effects over time should give the government confidence that the debt policy is working. So, debt dynamics still need to be a reason to worry because they would help the economy overall. Because it has a negligible effect on the economy immediately and lowers inflation, the government should pay less attention to the amount of debt and how quickly it grows.

Deficit sustainability and fiscal theory of price level: the case of Italy, 1861–2020

We test sustainability of the Italian government deficit over the period 1861–2020 using the fiscal theory of the price level (FTPL). This approach takes into account monetary and fiscal policy interactions and assumes that fiscal policy may determine the price level even if monetary authorities pursue an inflation-targeting strategy. We consider a cointegrated model with multiple structural changes to characterize the sustainability of public finances and the prevalence of monetary or fiscal dominance during subperiods. We also use recursive unit root tests for explosiveness to test fiscal sustainability and to detect episodes of potential explosive behaviour in Italian public debt. We find two structural changes for the public debt and one change in the primary budget surplus, the alternation of monetary and fiscal dominant regimes, as well as evidence of bubbles related to three episodes of the Italian fiscal performance. Our results reveal the sensitiveness of the primary balance and the debt paths to shocks hitting fiscal, macroeconomic, and financial variables.

Asymmetric Effects of Fiscal Deficit Financing and Inflation Dynamics in Ghana

Fiscal Deficit Financing (FDF) has been unsustainably high in Ghana and this has led to unstable and high inflation episodes since 1980. The FDF averaged 4.6% from 2005-2011 and 6.9% to 2012-2018, while inflation averaged 11.0% and 13.1% relative to medium-term to long-term inflation target of 8.0% in the same periods, respectively. Previous studies on deficit financing-inflation nexus in Ghana have primarily focused on linear and symmetric relationship, thereby ignoring the asymmetric policy effects of FDF on inflation dynamics. Disregarding the asymmetry of FDF could impact negatively on efforts of Bank of Ghana in forecasting and controlling inflation effectively. To address this problem, this study was therefore designed to investigate the asymmetric policy effects of FDF on inflation dynamics in Ghana over the period 1980-2018. The fiscal theory of the price level provided the theoretical framework. The Non-linear Autoregressive Distributed Lag (NARDL) econometric methodology was deployed to examine the asymmetric effects of FDF on inflation dynamics. The paper found that FDF had asymmetric effects on inflation dynamics in Ghana as the positive outcome of FDF had a significant positive asymmetric effect of 29.0% on inflation while its negative outcome had a relatively less asymmetric effect of 22% on inflation dynamics, suggesting that consolidating fiscal policy was disinflationary. The paper finally recommends that fiscal authorities should adopt consolidating and prudent fiscal policies that could lead to fiscal solvency and sustainability, which could potentially moderate the effect of FDF on inflation dynamics.

The Fiscal Theory of the Price Level in New Keynesian Models with Capital

The Fiscal Theory of the Price Level in New Keynesian Models with Capital

A modern approach to monetary and fiscal policy

This paper puts forth a systematic approach to teaching fiscal-monetary interactions that follows the view of one of the fathers of the Fiscal Theory of the Price Level (FTPL), Eric Leeper. The main advantage of this setup is its simplicity, which makes it particularly suited for undergraduates and non-specialists. It relies on a two-graph device to show that fiscal and monetary policies always get determined simultaneously and that their effects on the economy always depend on one another’s behavior. It is straightforward to see that in a conventional monetarist world (Regime M), the central bank succeeds in controling inflation so long as the fiscal authority does its job of ensuring that public debt does not grow too much. By contrast, in an alternative fiscal-dominant regime (Regime F), fiscal policy determines the price level (and inflation) in the short run, and the optimal monetary stance is holding the policy rate constant, since if the central bank otherwise tries to fight back fiscally determined inflation, it will worsen fiscal sustainability and increase future inflation.

Interpreting Modern Monetary Reality

During the 1990s and 2000s, the quantity theory of money (QTM) fell out of favor both among policymakers and academics. Central bankers almost universally adopted short‐term interest rates as their policy instruments while money was often dropped entirely from the dominant theoretical macro models.The central bank response to the global financial crisis—which featured the large‐scale asset purchases called “QE”—breathed life back into the quantity theory and its adherents. The widespread, though in fact mistaken, belief that central banks were targeting an increase in money growth to stave off deflation elicited memories of Milton Friedman's famous claim that the Fed could and should have accelerated money growth to bring the U.S. out of the Great Depression. That belief also led to alarming predictions that central banks in the wake of the GFC were massively overdoing it. The Fed's policy led to a nearly fourfold increase in the U.S. monetary base from August 2008 to August 2014!But as things turned out, this monetary expansion turned out to be much ado about nothing. During the 13‐year period ending in December 2020 in which U.S. M1 grew by an annual average rate of 12.7%, inflation averaged just 1.6%. The prediction of QTM that inflation would mirror money growth over the long run has been wildly off the mark and, although things could change quickly, even today's capital market expectations for “long run” U.S. inflation appear to be running within a 2%‐3% band.In this article, the former IMF director of central banking explains why the QTM is no longer a useful “cheat code” for interpreting modern monetary reality. As the most promising replacement, the author offers the outline of a “fiscal theory of the price level” that has had more success in explaining global inflation during the past several decades. As its name suggests, the fiscal theory emphasizes that the underlying driver of inflation is government deficit spending while minimizing the importance of the instruments—whether money or debt—that governments use to finance their deficits. The QTM, by contrast, effectively assumes that whereas money finance is likely to be inflationary, bond finance is not.Among the most compelling features of the fiscal theory is to draw attention to the transformation of global capital markets during the past several decades that has brought government debt finance to the fore while diminishing the role of money finance. When assessing the inflationary consequences of permanent fiscal expansions, policymakers must consider both government monetary and non‐monetary liabilities. Because the policy response to the GFC involved primarily the exchange of bond financing for monetary financing without a significant increase in total sovereign debt, it did not prove inflationary. The response to the global pandemic, by contrast, has involved a significant deterioration in sovereign fiscal finances. But whether this turns out to be inflationary is likely to depend not on how the current deficits are financed in the moment, but on the commitment of sovereigns to shoring up their fiscal positions without resorting to a reduction in the real value of their own debt.

A macroeconomic theory of price determination

Motivated by disputes over the quantity theory of money and the fiscal theory of the price level (the FTPL), I consider price determination in another macro model which can be used both in the short run and in the long run. It is a two-sector model with flexible prices and profit-maximizing firms. Government and the foreign sector are also included. It is assumed that prices are determined by supply and demand in the short run unlike in the quantity theory and the FTPL. In particular the determination of the price of consumption goods is pursued. Finally the FTPL is examined.

A fiscal theory of monetary policy with partially-repaid long-term debt

I construct a simple model with sticky prices and interest rate targets, closed by fiscal theory of the price level with long-term debt and fiscal and monetary policy rules. Fiscal surpluses rise following deficits, to repay accumulated debt, but surpluses do not respond to all values of unexpected inflation and deflation. This specification avoids common puzzles and produces reasonable responses to fiscal and monetary policy shocks. It allows an easy translation of any new-Keynesian model, and it allows one to study a whole sample with active fiscal policy.

Establishing a Fiscal Dialogue in Europe.

In this contribution, I use the fiscal theory of the price level as a backdrop for a discussion on the risks that expansionary fiscal policies may pose on debt sustainability. I recall that a regime of fiscal dominance does not lead to macroeconomic instability. I also review a few empirical papers on fiscal sustainability and I conclude, also based upon own estimates, that it is not a major concern, at least in the short to mid-run. Finally, I argue that Europeans should continue on the fiscal impetus they contributed to in 2020 by fostering coordination and transparency on EU fiscal policies. To achieve this objective, I revisit the idea of an enhanced dialogue on fiscal matters at the European Parliament and propose to establish a Fiscal Dialogue with the EU Member States.

Revisiting the Dynamics of the Fiscal Deficit and Inflation in India: the Nonlinear Autoregressive Distributed Lag Approach

The chronic government deficit (fiscal deficit) and increase in the price level (inflation) have become major concerns for economists and policymakers. While numerous studies have examined the twin problems of the fiscal deficit and inflation for both developed and developing economies, their results are inconclusive due to different estimation techniques, chosen time periods, selection of variables, etc. Therefore, we examined the fiscal deficit-inflation nexus in India for the period from 1980–81 to 2016–17 by employing the Autoregressive Distributed Lag (ARDL) and Nonlinear Autoregressive Distributed Lag (NARDL) approaches. The results of the ARDL approach found no evidence of linear relationship between fiscal deficit and inflation in the Indian context. Further, the empirical findings of the NARDL model confirmed the nonlinear relationship between fiscal deficit and inflation in the long run and no association between money supply and inflation, supporting the ideas of the Fiscal Theory of the Price Level (FTPL) in the case of India. FTPL postulates that public debt and taxation policies drive price level; monetary policy has an indirect role only. Therefore, fiscal policymakers should focus on reducing fiscal deficits. Simultaneously, the Reserve Bank of India (RBI) should regulate lending interest rate so that a mix of fiscal and monetary policies can be applied for controlling inflation in India.

RAMSEY OPTIMAL POLICY IN THE NEW-KEYNESIAN MODEL WITH PUBLIC DEBT

In the discrete-time new-Keynesian model with public debt, Ramsey optimal policy eliminates the indeterminacy of simple-rules multiple equilibria between the fiscal theory of the price level versus new-Keynesian versus an unpleasant equilibrium. If public debt volatility is taken into account into the loss function, the interest rate responds to public debt besides inflation and output gap. Else, the Taylor rule is identical to Ramsey optimal policy when there is zero public debt. The optimal fiscal-rule parameter implies the local stability of public-debt dynamics (“passive” fiscal policy).

U.S. Macro Policies and Global Economic Challenges

This paper overviews different exit strategies for the U.S. from the debt-overhang, and analyses their implications for emerging markets and global stability. These strategies are discussed in the context of the debates about secular-stagnation versus debt-overhang, the fiscal theory of the price level, the size of fiscal multipliers, prospects for a multipolar currency system, and historical case studies. We conclude that the reallocation of U.S. fiscal efforts towards infrastructure investment aiming at boosting growth, followed by a gradual tax increase, aiming at reaching a modest primary fiscal surplus over time are akin to an upfront investment in greater long-term global stability. Such a trajectory may solidify the viability and credibility of the U.S. dollar as a global anchor, thereby stabilizing Emerging Markets economies and global growth. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Determinacy Without the Taylor Principle

A long-standing issue in the theory of monetary policy is that the same path for the interest rate can be associated with multiple bounded equilibrium paths for inflation and output. We show that a small friction in memory and intertemporal coordination can remove this indeterminacy. This leaves no space for equilibrium selection by means of either the Taylor Principle or the Fiscal Theory of the Price Level. It reinforces the logical foundations of the New Keynesian model’s conventional solution (a.k.a. its fundamental or MSV solution). And it liberates feedback rules to serve only one function: stabilization.

The Prospect of Fiscal Dominance in the United States: A New Quantity Theory Perspective

The U.S. national debt is now near 100 percent of GDP and is expected to double that by 2050, according to the Congressional Budget Office. This change in U.S. public finance has some observers worried that a regime of fiscal dominance may soon emerge, making monetary policy subservient to fiscal policy. This paper provides an alternative interpretation of these facts: the elevated debt-to-GDP alongside well-anchored inflation expectations reflects an elevated real demand for government securities. This interpretation can be shown using a New Quantity Theory that falls out of the recent work on the Fiscal Theory of the Price Level with a bubble.

Puzzles of Inflation, Money, and Debt: Applying the Fiscal Theory of the Price Level

Puzzles of Inflation, Money, and Debt: Applying the Fiscal Theory of the Price Level