Policy Interaction, Learning and the Fiscal Theory of Prices
University of Oregon, Economics Working Paper No. 241; Bank of Finland Discussion Paper No. 18/2002
32 Pages Posted: 22 Apr 2003
Date Written: August 28, 2002
We investigate both the rational explosive inflation paths studied by McCallum (2001) and the classification of fiscal and monetary policies proposed by Leeper (1991) for stability under learning of rational expectations equilibria (REE). Our first result is that the fiscalist REE in the model of McCallum (2001) is not locally stable under learning. By contrast, in the setting of Leeper (1991), different possibilities can obtain. We find, in particular, that there are parameter domains for which the fiscal theory solution - in which fiscal variables affect the price level - can be a stable outcome under learning. For other parameter domains, the monetarist solution is the stable equilibrium.
Keywords: Inflation, expectations, fiscal and monetary policy, explosive price paths
JEL Classification: E52, E31, D84
Suggested Citation: Suggested Citation