Prices and Inflation when Government Bonds are Net Wealth

Marcus Hagedorn

No 12769, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this paper I show that models in which government bonds are net wealth - that is, their value exceeds that of tax liabilities (Barro, 1974) - offer a new perspective on several issues in monetary economics. First and foremost, prices and inflation are jointly and uniquely determined by fiscal and monetary policy. In contrast to the conventional view, the long-run inflation rate here is, in the absence of output growth, and even when monetary policy operates an interest rate rule with a different inflation target, equal to the growth rate of nominal fiscal variables, which are controlled by fiscal policy. This novel theory also offers a different perspective on the fiscal and monetary transmission mechanism, policies at the zero-lower bound, U.S. inflation history, recent attempts to stimulate inflation in the Euro area and several puzzles which arise in New Keyensian models during a liquidity trap. To derive my findings, I first use a reduced form approach in which households derive utility from holding bonds. I prove how and for which policy rules the price level is globally determinate, then showing that the reduced form results carry over to a Bewley-Imrohoroglu-Huggett-Aiyagari heterogenous agent incomplete markets model.

Keywords: Price level determinacy; Ricardian equivalence; Incomplete markets; inflation; Monetary policy; Fiscal policy; Policy coordination (search for similar items in EconPapers)
JEL-codes: D52 E31 E43 E52 E62 E63 (search for similar items in EconPapers)
Date: 2018-03
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (24)

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