Jointly with the Journal of Economic Dynamics and Control, the St. Louis Fed, the University of Bern and the Swiss National Bank, the Study Center Gerzensee organized a conference on Fiscal and Monetary Policies. The program can be viewed here.
In a recent Citigroup Global Economics View Research report, Willem Buiter discusses “Bad and Good ‘Fiscal Theories of the Price Level’.” Quoting my own work on the Fiscal Theory, Buiter warns that policy makers start to pay attention to the theory:
It does not often happen that a rather obscure technical bit of economic theory
merits an audience wider than the small band of academics who spend their waking
hours pondering such matters because that is the kind of thing they do. This note
addresses one of those occasions. The obscure economic theory in question is the
so-called fiscal theory of the price level (FTPL) …
The destruction of the logic of the FTPL by Buiter and Niepelt ought to have been
the end of the FTPL – their arguments were never refuted. … Recently, some of the originators of the original FTPL have tried to resurrect it …
In the Richmond Fed’s Econ Focus, Eric Leeper explains his views.
- Disparate confounding dynamics and simple policy rules:
My view is that central banks have put far too many resources into understanding tiny fluctuations and too few resources into the things that actually matter. …
Something like the basic Taylor rule doesn’t really serve as a useful litmus test for what policy is doing in the face of these DCDs, so it’s a little bizarre to me that a lot of central banks routinely calculate what the path of the interest rate would be with a simple Taylor rule as if that’s a useful benchmark. It’s not obvious to me what that’s a benchmark for.
- Active/passive policy regimes, the fiscal theory of the price level and whether current or previous policy mixes are or were characterized by active fiscal policy:
Now, how all of [current policy] ties into the active/passive framework is really an open question. A lot of it depends on what you think is going to happen to the Fed’s balance sheet.
… the recovery from the Great Depression in 1933 when Roosevelt took the United States off the gold standard. Going off the gold standard converted government debt from effectively real debt to nominal debt because the price level under the gold standard was beyond the control of the government. At the same time, the fiscal actions Roosevelt undertook were what nowadays we would call an unbacked fiscal expansion. … This is like a fiscal rule that says the government will run deficits until the price level recovers to some pre-depression level. And the Fed was just keeping the interest rate flat. So it looked a lot like passive monetary/ active fiscal.
- Walls between monetary and fiscal policy:
The thing is, there’s not a lot of theoretical justification for creating these walls. What we’re finding more and more is that there’s always some role in optimal policy for using surprise inflation to revalue debt and bond prices, so long as there is some maturity to government debt. … maybe it is a slippery slope once you’re in the political realm. But from an academic perspective, if your objective is to arrive at a rule that would be mechanically followed by a central bank, then there’s no harm in having fiscal variables enter that rule.
A conference at the University of Chicago’s Becker Friedman Institute addressed the status of the Fiscal Theory of the Price Level and the theory’s implications for current policy. Slides and papers are available on the conference website. Given that the conference was meant to resuscitate research on the FTPL and that the participants were selected accordingly, many contributions appear rather mainstream.
Chris Sims worries about indeterminacy of the price level if monetary policy is constrained by the ZLB and fiscal policy is passive.
The key thing here is that the central bank determines prices and inflation without any fiscal support. If the idea you got from the FTPL is that fiscal policy is necessary to determine the price level and inflation, that’s not correct. …
So, the conclusions are:
- FTPL forces us to think seriously about fiscal/monetary interaction, and that’s very important. But fiscal support is not necessary for monetary policy to work, nor is it useful to think of fiscal policy determining inflation on its own – the central bank can indeed be independent.
- Fiscal/monetary interaction becomes really important when we start thinking about the liquidity properties of government debt.
- Helicopter drops? Forget it. This is not some cure-all for a low-inflation problem.
- QE can be harmful, as it soaks up useful collateral and replaces it with inferior assets.
- Neo-Fisherian denial is not good for you. Central banks that want to increase inflation need to increase nominal interest rates.
John Cochrane argues that to get the cyclical properties of inflation “right” one should focus on the discount factor in the core FTPL equation, not the primary government surplus. The discount factor might also be affected by monetary policy. See also his blog post.
Harald Uhlig remains very skeptical and points to the lack of evidence favoring the FTPL. On his first slide, he asks:
- What does FTPL want to be?
– A theory that can be consistent with the data? OK
– An equation needed to complete a system? OK
– A theoretical or extreme possibility? OK
– A set of predictions, which occasionally work in exotic circumstances (“Brazil”)? PERHAPS
– A set of predictions, which help often (“Taylor coeff < 1”)? ?
– A useful framework for practitioners? ?
– The miracle cure for the failures of other inflation theories? ?
– A framework for the key interplay of fiscal and monetary policy? ?
- Where is the “smoking gun”? What set of facts “scream” FTPL? Specific predictions?
- Why is sovereign default off the table? Sure, a central bank can accommodate by inflating away debt … is that all?
- The US, Japan, the Eurozone have a near-deflation problem (is it?). Do you advocate “irresponsible” fiscal policies to solve this?
- What advice would you give the sunspot-branch of macro?
Quarterly Journal of Economics 119(1), February 2004. PDF.
I examine the “fiscal theory of the price level” according to which “non-Ricardian” policy and predetermined nominal government debt fiscally determine prices. I argue that the non-Ricardian policy assumption and, by implication, fiscal price level determination are inconsistent with an equilibrium in which all asset holdings reflect optimal household choices. In such an equilibrium, policy must be Ricardian even if, in some states of nature, the government defaults or commits to an arbitrary real primary surplus sequence. I propose an alternative to the fiscal theory of the price level, based on nominal flows instead of nominal stocks. While this alternative framework establishes a consistent link between fiscal policy and the price level, it does not introduce inflationary fiscal effects beyond those suggested by Sargent and Wallace.