Policy Interaction, Learning and the Fiscal Theory of Prices

Evans, George W.; Honkapohja, Seppo

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Policy Interaction, Learning and the Fiscal Theory of Prices

30 Pages Posted: 1 Nov 2002

See all articles by George W. Evans

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

There are 2 versions of this paper

Date Written: October 2002

Abstract

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: D84, E31, E52

Suggested Citation: Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Policy Interaction, Learning and the Fiscal Theory of Prices (October 2002). Available at SSRN: https://ssrn.com/abstract=346640