Understanding the Fiscal Theory of the Price Level

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NBER WORKING PAPER SERIES UNDERSTANDING THE FISCAL THEORY OF THE PRICE LEVEL Lawrence J. Christiano Terry J. Fitzgerald Working Paper 7668 http://www.nber.org/papers/w7668 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 April 2000 We have benefitted from discussions with Stefania Albanesi, Marco Bassetto, Charles Carlstrom, Martin Eichenbaum, and Timothy Fuerst. We are particularly grateful for the tireless efforts of John Cochrane, Christopher Sims and Michael Woodford to educate us on the fiscal theory. Christiano acknowledges financial support from an NSF grant to the National Bureau of Economic Research. The views expressed herein are those of the authors and are not necessarily those of the National Bureau of Economic Research. © 2000 by Lawrence J. Christiano and Terry J. Fitzgerald. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Transcript of Understanding the Fiscal Theory of the Price Level

NBER WORKING PAPER SERIES

UNDERSTANDING THE FISCAL THEORY OF THE PRICE LEVEL

Lawrence J. ChristianoTerry J. Fitzgerald

Working Paper 7668http://www.nber.org/papers/w7668

NATIONAL BUREAU OF ECONOMIC RESEARCH1050 Massachusetts Avenue

Cambridge, MA 02138April 2000

We have benefitted from discussions with Stefania Albanesi, Marco Bassetto, Charles Carlstrom, MartinEichenbaum, and Timothy Fuerst. We are particularly grateful for the tireless efforts of John Cochrane,Christopher Sims and Michael Woodford to educate us on the fiscal theory. Christiano acknowledgesfinancial support from an NSF grant to the National Bureau of Economic Research. The views expressedherein are those of the authors and are not necessarily those of the National Bureau of Economic Research.

© 2000 by Lawrence J. Christiano and Terry J. Fitzgerald. All rights reserved. Short sections of text, notto exceed two paragraphs, may be quoted without explicit permission provided that full credit, including ©notice, is given to the source.

Understanding the Fiscal Theory of the Price LevelLawrence J. Christiano and Terry J. FitzgeraldNBER Working Paper No. 7668April 2000JEL No. E5, E58, E6, E61, E62

ABSTRACT

We review the fiscal theory of the price level. We place special emphasis on the theory’s

implications for the feasibility of price stability.

Lawrence J. Christiano Terry J. Fitzgerald Department of Economics Research Department Northwestern University Federal Reserve Bank of Cleveland 2003 Sheridan Road East 6th and Superior Evanston, Illinois 60628-2600 Cleveland, Ohio 44101 and NBER [email protected]

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Figure 1: Debt Evolution Under non-Ricardian Fiscal Policy

End of Period Real Debt

Beginning of Period Real Debt

Figure 2: Debt Evolution Under Perturbed Fiscal Policy

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