The Fiscal Theory of the Price Level with a Bubble
78 Pages Posted: 14 May 2020
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The Fiscal Theory of the Price Level with a Bubble
The Fiscal Theory of the Price Level with a Bubble
Date Written: 2020
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.
JEL Classification: E440, E520, E630
Suggested Citation: Suggested Citation