Working Paper: CEPR ID: DP1772
Authors: Matthew B. Canzoneri; Robert E. Cumby; Behzad T. Diba
Abstract: A new theory of price determination suggests that if primary surpluses are independent of the level of debt, the price level has to ?jump? to assure fiscal solvency. In this regime (which we call fiscal dominant), monetary policy has to work through seignorage to control the price level. If, on the other hand, primary surpluses are expected to respond to the level of debt in a way that assures fiscal solvency (a regime we call money dominant), then the price level is determined in more conventional ways. This paper develops testable restrictions that differentiate between the two regimes. Using post-war data, the paper presents what we think is overwhelming evidence that the United States is in a money dominant regime; even the post-Reagan data (1980?95) seem to support that contention.
Keywords: price determination; monetary policy; fiscal policy
JEL Codes: E31; E42; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fiscal policy (primary surpluses) (E62) | price level (E30) |
| lack of adjustment in primary surpluses (F32) | price level jumps (E30) |
| primary surpluses (H62) | debt levels (H63) |
| price level (E30) | aggregate demand management (E00) |
| surplus to GDP ratio innovation (O49) | liabilities to GDP ratio (F65) |
| surpluses (H62) | pay off debt (G51) |
| innovations in surplus (O35) | future surpluses (H62) |