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Policy rules under the monetary and the fiscal theories of the price-level

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  • Jagjit S. Chadha

Abstract

Price-level determination requires co-ordination of monetary and fiscal policy to ensure a unique rational expectations equilibrium (REE). This paper derives a number of implications for simple interest rate rules resulting from various fiscal strategies. We show that fiscal choices under either the monetary theory of the price-level (MTPL) and the fiscal theory of the price-level (FTPL) can challenge widely accepted principles of monetary policy. Specifically, we show that a fiscal rule that responds aggressively to output and inflation may force the monetary authorities to adopt significantly more aggressive output and inflation stabilization policy than suggested by the Taylor Principle. We also show how when monetary policy is severely constrained, the fiscal policy maker can act to stabilise the economy. Some policy conclusions in light of the lower zero bound for monetary policy and debt stabilization are drawn.

Suggested Citation

  • Jagjit S. Chadha, 2011. "Policy rules under the monetary and the fiscal theories of the price-level," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 4(2), pages 189-212, December.
    • Handle: RePEc:taf:macfem:v:4:y:2011:i:2:p:189-212
    DOI: 10.1080/17520843.2011.557389
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    References listed on IDEAS

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    1. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14, National Bureau of Economic Research, Inc.
    2. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348, National Bureau of Economic Research, Inc.
    3. Schmitt-Grohe, Stephanie & Uribe, Martin, 2000. "Price level determinacy and monetary policy under a balanced-budget requirement," Journal of Monetary Economics, Elsevier, vol. 45(1), pages 211-246, February.
    4. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, February.
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    Cited by:

    1. Chadha, J.S. & Corrado, L., 2007. "On the Determinacy of Monetary Policy under Expectational Errors," Cambridge Working Papers in Economics 0722, Faculty of Economics, University of Cambridge.
    2. Jagjit S. Chadha & Luisa Corrado, 2006. "On the Determinacy of Monetary Policy under Expectational Errors," CDMA Working Paper Series 200603, Centre for Dynamic Macroeconomic Analysis, revised 15 Apr 2007.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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