Teria monetaria y fiscal

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Int Tax Public Finan (2006) 13:373–409 DOI 10.1007/s10797-006-8599-2

Monetary-fiscal policy interactions and the price level: Background and beyond
Eric M. Leeper · Tack Yun

C

Springer Science + Business Media, LLC 2006

Abstract The paper presents the fiscal theory of the price level in a variety of models, including endowment economies with lump-sum taxes and production economies withproportional income taxes. We offer a microeconomic perspective on the fiscal theory by computing a Slutsky-Hicks decomposition of the effects of tax changes into substitution, wealth, and revaluation effects. Revaluation effects arise whenever tax changes alter the value of outstanding nominal government liabilities by changing the price level. Under certain assumptions on monetary and fiscalbehavior, the revaluation effect reflects the fiscal theory mechanism. When taxes distort, two Laffer curves arise, implying that a tax increase can lower or raise the price level and the revaluation effect can be positive or negative, depending on which side of a particular Laffer curve the economy resides. Keywords Income taxes . Inflation . Debt revaluation . Laffer curve Jel Code: E31 . E52 . E62 1.Introduction Occasionally a new idea in macroeconomics generates professional reactions that are, in equal parts, excitement and vitriol. The fiscal theory of the price level is such an
E. M. Leeper ( ) Department of Economics and Center for Applied Economics and Policy Research, Indiana University and NBER e-mail: eleeper@indiana.edu T. Yun Monetary Affairs Division, Federal Reserve Board e-mail:Tack.Yun@frb.gov

Springer

374

E. M. Leeper, T. Yun

idea. It is provocative because it attributes to fiscal policy a potentially important role in determining the general level of prices in the economy, placing it in direct competition with the venerable quantity theory of money. At the same time, the fiscal theory constitutes a new channel for breaking Ricardian equivalence—one thatcomes from the valuation of nominal government liabilities. Unlike existing methods for deviating from Ricardian equivalence, which rely on market imperfections, myopic consumers, or tax distortions, the fiscal theory arises from particular combinations of monetary and fiscal policies. The label “the fiscal theory of the price level” would seem to imply that fiscal policy alone determines the pricelevel, and this is certainly the tone of several papers on the topic. We regard the label to be a misnomer. In all theories of price level determination—whether the fiscal theory or the quantity theory—the equilibrium price level emerges from particular combinations of monetary and fiscal policy behavior. In both theories it is impossible to even derive an equilibrium without completely specifying bothmonetary and fiscal behavior. Where the theories part company is in their predictions of how monetary or fiscal changes affect the price level. The fiscal theory lurks in any dynamic model with monetary and fiscal policies. The theory’s linchpin is a ubiquitous dynamic equilibrium condition that equates the real value of total nominal government liabilities—typically high-powered money plus unindexeddebt—to the expected discounted present value of net-of-interest surpluses plus seigniorage.1 This condition stems from combining the government’s intertemporal budget constraint with some private-sector optimality conditions. Critiques of the fiscal theory spring, in large part, from interpretations of the role this condition plays in determining equilibrium. This paper tries to avoid thecontroversy surrounding the fiscal theory by describing it in ways that do not get mired in interpretation of the contentious equilibrium condition. Instead, the paper takes a more microeconomic approach to show how the fiscal theory works in several conventional models. First, Section 2 uses a permanent income model to describe the fiscal theory mechanism in partial equilibrium terms. In Section 3 we...
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