Research Discussion Papers, Bank of Finland
No 18/2002:
Policy interaction, learning and the fiscal theory of prices
George W. Evans and Seppo Honkapohja
Abstract: We investigate both the rational explosive inflation paths
studied by McCallum (2001) and the classification of fiscal and monetary
policies proposed by Leeper (1991) for stability under learning of rational
expectations equilibria (REE). Our first result is that the fiscalist REE
in the model of McCallum (2001) is not locally stable under learning. By
contrast, in the setting of Leeper (1991), different possibilities can
obtain. We find, in particular, that there are parameter domains for which
the fiscal theory solution – in which fiscal variables affect the price
level – can be a stable outcome under learning. For other parameter
domains, the monetarist solution is the stable equilibrium.
Keywords: inflation; expectations; fiscal and monetary policy; explosive price paths; (follow links to similar papers)
JEL-Codes: D84; E31; E52; (follow links to similar papers)
32 pages, August 28, 2002
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