The Fiscal Theory of the Price Level with a Bubble

78 Pages Posted: 14 May 2020

See all articles by Markus K. Brunnermeier

Markus K. Brunnermeier

Princeton University - Department of Economics

Sebastian Merkel

Princeton University

Yuliy Sannikov

Stanford GSB

Multiple version iconThere are 2 versions of this paper

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

Brunnermeier, Markus Konrad and Merkel, Sebastian and Sannikov, Yuliy, The Fiscal Theory of the Price Level with a Bubble (2020). CESifo Working Paper No. 8278, Available at SSRN: https://ssrn.com/abstract=3598764 or http://dx.doi.org/10.2139/ssrn.3598764

Markus Konrad Brunnermeier (Contact Author)

Princeton University - Department of Economics ( email )

Bendheim Center for Finance
Princeton, NJ
United States
609-258-4050 (Phone)
609-258-0771 (Fax)

HOME PAGE: http://www.princeton.edu/¡­markus

Sebastian Merkel

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

Yuliy Sannikov

Stanford GSB ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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