Working Paper: NBER ID: w26745
Authors: John H. Cochrane
Abstract: I construct a simple model with sticky prices and interest rate targets, closed by fiscal theory of the price level with long-term debt and fiscal and monetary policy rules. Fiscal surpluses rise following deficits, to repay accumulated debt, but surpluses do not respond to all values of unexpected inflation and deflation. This specification avoids common puzzles and produces reasonable responses to fiscal and monetary policy shocks. It allows an easy translation of any new-Keynesian model, and it allows one to study a whole sample with active fiscal policy.
Keywords: Fiscal Theory; Monetary Policy; Long-Term Debt; Inflation; Output Dynamics
JEL Codes: E3; E31; E32; E4; E5; E6; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fiscal surpluses (H62) | real value of debt (H63) |
| real value of debt (H63) | inflation (E31) |
| fiscal surpluses (H62) | inflation (E31) |
| unexpected monetary policy shocks (E39) | disinflation (E31) |
| unexpected monetary policy shocks (E39) | output decline (E23) |
| nominal interest rates (E43) | inflation (E31) |