Working Paper: CEPR ID: DP3564
Authors: G. W. Evans; 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 the rational expectations equilibria (REE). Our first result is that the fiscalist REE in the model of McCallum (2001) is not locally stable under learning. In contrast, in the setting of Leeper (1991), different possibilities can arise. 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, however, the monetarist solution is instead the stable equilibrium.
Keywords: Expectations; Explosive Price Paths; Fiscal and Monetary Policy; Inflation
JEL Codes: D84; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscalist rational expectations equilibrium (REE) from McCallum's model (2001) (E62) | Not locally stable under learning (C62) |
| Fiscal theory solution under Leeper's framework (E62) | Stable under learning in certain parameter domains (C62) |
| Fiscal variables (E62) | Price level (E30) |