Working Paper: NBER ID: w11646
Authors: Eric M. Leeper; Tack Yun
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 with proportional 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 fiscal behavior, 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: fiscal theory of the price level; monetary policy; fiscal policy; price level determination
JEL Codes: E31; E52; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy (E62) | Equilibrium price level (E30) |
| Tax changes (H29) | Expected present value of surpluses (D15) |
| Expected present value of surpluses (D15) | Equilibrium price level (E30) |
| Tax changes (H29) | Equilibrium price level (E30) |