Financial Frictions and the Fiscal Theory of Price Level Determination

Libo Xu and Apostolos Serletis
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Libo Xu: University of Calgary

Open Economies Review, 2017, vol. 28, issue 2, No 3, 272 pages

Abstract: Abstract The fiscal theory of the price level represents a significant departure from the quantity theory of money, as it implies that active (non-Ricardian) fiscal policy provides the nominal anchor and determines the price level. In this paper we take a first pass at integrating discussion of financial frictions and the fiscal theory of the price level. We first present empirical evidence in support of non-Ricardian fiscal policy, and then discuss the fiscal theory of the price level in a world with financial frictions. After illustrating how the financial friction influences the price level, we provide a theoretical explanation to our empirical findings. We also argue that the financial friction, which is related to fiscal policy, provides an additional instrument tool to the fiscal authority and an advantage over the monetary authority in choosing the equilibrium.

Keywords: Collateral rates; Fiscal theory of the price level; Monetary-fiscal interactions (search for similar items in EconPapers)
JEL-codes: E31 E58 H63 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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Working Paper: Financial Frictions and the Fiscal Theory of Price Level Determination (2016)
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DOI: 10.1007/s11079-016-9422-z

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