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Financial Frictions and the Fiscal Theory of Price Level Determination

Author

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  • Libo Xu

    (University of Calgary)

  • Apostolos Serletis

    (University of Calgary)

Abstract

The fiscal theory of the price level represents a significant departure from the quantity theory of money, as it implies that active (non-Ricardian) fiscal policy provides the nominal anchor and determines the price level. In this paper we take a first pass at integrating discussion of financial frictions and the fiscal theory of the price level. We first present empirical evidence in support of non-Ricardian fiscal policy, and then discuss the fiscal theory of the price level in a world with financial frictions. After illustrating how the financial friction influences the price level, we provide a theoretical explanation to our empirical findings. We also argue that the financial friction, which is related to fiscal policy, provides an additional instrument tool to the fiscal authority and an advantage over the monetary authority in choosing the equilibrium.

Suggested Citation

  • Libo Xu & Apostolos Serletis, 2017. "Financial Frictions and the Fiscal Theory of Price Level Determination," Open Economies Review, Springer, vol. 28(2), pages 251-272, April.
    • Handle: RePEc:kap:openec:v:28:y:2017:i:2:d:10.1007_s11079-016-9422-z
    DOI: 10.1007/s11079-016-9422-z
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    Cited by:

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    3. Ranjan Kumar Mohanty & N. R. Bhanumurthy, 2021. "Revisiting the role of fiscal policy in determining interest rate in India," Journal of the Asia Pacific Economy, Taylor & Francis Journals, vol. 26(2), pages 293-318, April.

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    More about this item

    Keywords

    Collateral rates; Fiscal theory of the price level; Monetary-fiscal interactions;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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