Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences

Posted: 29 Feb 2008

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Edward Nelson

Board of Governors of the Federal Reserve System

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Abstract

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 rational expectations 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 rational expectations 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.

Suggested Citation

McCallum, Bennett T. and Nelson, Edward, Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences. Oxford Review of Economic Policy, Vol. 21, Issue 4, pp. 565-583, 2005, Available at SSRN: https://ssrn.com/abstract=906418

Bennett T. McCallum (Contact Author)

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Edward Nelson

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