Working Paper: NBER ID: w27116
Authors: Markus K. Brunnermeier; Sebastian A. Merkel; Yuliy Sannikov
Abstract: This paper incorporates a bubble term in the standard Fiscal Theory of the Price Level equation to explain why countries with persistently negative primary surpluses can have a positively valued currency and low inflation. It also provides two illustrative models with closed-form solutions in which the return on government bonds is below the economy’s growth rate. The government can “mine” the bubble by perpetually rolling over its debt. Despite the bubble, the price level remains determined provided government policy credibly promises primary surpluses off-equilibrium. Sufficient “fiscal space” ensures that the bubble term is attached to government bonds rather than other assets, like crypto assets. The analysis provides a new perspective on debt sustainability analysis.
Keywords: Fiscal theory; Price level; Bubbles; Government debt
JEL Codes: E44; E52; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real interest rate (r) is persistently below the growth rate (g) (E43) | bubble exists in government debt (H63) |
| decline in expected future primary surpluses (H68) | increase in price level (higher inflation) (E31) |
| credible fiscal policy (E62) | maintain bubble in equilibrium (E32) |
| bubble existence (E32) | government can finance expenditures without raising taxes (H69) |
| aggressive bubble mining (E32) | potential inflationary impacts (E31) |