Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences
Bennett T. McCallum
Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)
Federal Reserve Bank of St. Louis - Research Division; Board of Governors of the Federal Reserve System
FRB of St. Louis Working Paper No. 2006-010A
The fiscal theory of the price level (FTPL) has attracted much attention but disagreement remains concerning its defining characteristics. Some writers have emphasized implications regarding interest-rate pegging and determinacy of RE solutions, whereas others have stressed its capacity to generate equilibria in which price level trajectories mimic those of bonds and differ drastically from those of money supplies. We argue that the FTPL attained prominence precisely because it appeared to provide a theory whose implications differ greatly from conventional monetary analysis; accordingly we review monetarist writings to identify the primary distinctions. In addition, we review recent findings concerning learnability - and therefore plausibility - of competing RE equilibria. These indicate that when FTPL and monetarist equilibria differ, the latter are more plausible in the vast majority of cases. Under Ricardian assumptions, necessary for clear distinctions, theoretical analysis indicates that fiscal and monetary coordination is not necessary for macroeconomic stability.
Number of Pages in PDF File: 36
Keywords: Fiscal theory of the price level, quantity theory, monetarism, monetary-fiscal policy coordination
JEL Classification: E31, E52, E63
Date posted: March 13, 2006
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