A Requiem For The Fiscal Theory Of The Price Level
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A Requiem for the Fiscal Theory of the Price Level
Author: Mr.Roger Farmer
language: en
Publisher: International Monetary Fund
Release Date: 2019-10-11
The Fiscal Theory of the Price Level (FTPL) is the claim that, in a popular class of theoretical models, the price level is sometimes determined by fiscal policy rather than monetary policy. The models where this claim has been established assume that all decisions are made by an infinitely-lived representative agent. We present an alternative, arguably more realistic model, populated by sixty-two generations of people. We calibrate our model to an income profile from U.S. data and we show that the FTPL breaks down. In our model, the price level and the real interest rate are indeterminate, even when monetary and fiscal policy are both active. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies.
A Requiem for the Fiscal Theory of the Price Level
Author: Mr.Roger Farmer
language: en
Publisher: International Monetary Fund
Release Date: 2019-10-11
The Fiscal Theory of the Price Level (FTPL) is the claim that, in a popular class of theoretical models, the price level is sometimes determined by fiscal policy rather than monetary policy. The models where this claim has been established assume that all decisions are made by an infinitely-lived representative agent. We present an alternative, arguably more realistic model, populated by sixty-two generations of people. We calibrate our model to an income profile from U.S. data and we show that the FTPL breaks down. In our model, the price level and the real interest rate are indeterminate, even when monetary and fiscal policy are both active. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies.
A Requiem for the Fiscal Theory of the Price Level
We demonstrate that the Fiscal Theory of the Price Level (FTPL) cannot be used to determine the price level uniquely in the overlapping generations (OLG) model. We provide two examples of OLG models, one with three 3-period lives and one with 62-period lives. Both examples are calibrated to an income profile chosen to match the life-cycle earnings process in U.S. data estimated by Guvenen et al. (2015). In both examples, there exist multiple steady-state equilibria. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies. As long as the primary deficit or the primary surplus is not too large, the fiscal authority can conduct policies that are unresponsive to endogenous changes in the level of its outstanding debt. Monetary and fiscal policy can both be active at the same time.