Journal Article

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

Bennett T. McCallum and Edward Nelson

in Oxford Review of Economic Policy

Published on behalf of The Oxford Review of Economic Policy Ltd

Volume 21, issue 4, pages 565-583
Published in print January 2005 | ISSN: 0266-903X
Published online January 2005 | e-ISSN: 1460-2121 | DOI: http://dx.doi.org/10.1093/oxrep/gri032
Monetary and Fiscal Theories of the Price Level: The Irreconcilable Differences

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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.

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Subjects: Economic Development and Growth ; Public Economics ; Political Economy ; Public Policy

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