The Fiscal Theory of the Price Level

**A comprehensive account of how government deficits and debt drive inflation** Where do inflation and deflation ultimately come from? The fiscal theory of the price level offers a simple answer: Prices adjust so that the real value of government debt equals the present value of taxes less spending. Inflation breaks out when people don’t expect the government to fully repay its debts. The fiscal theory is well suited to today’s economy: Financial innovation undermines money demand, and central banks don’t control the money supply or aggressively change interest rates, invalidating classic theories, while large debts and deficits threaten inflation and constrain monetary policy. This book presents a comprehensive account of this important theory from one of its leading developers and advocates. John Cochrane aims to make fiscal theory useful as a conceptual framework and modeling tool, and for analyzing history and policy. He merges fiscal theory with standard models in which central banks set interest rates, giving a novel account of monetary policy. He generalizes the theory to explain data and make realistic predictions. For example, inflation decreases in recessions despite deficits because discount rates fall, raising the value of debt; specifying that governments promise to partially repay debt avoids classic puzzles and allows the theory to apply at all times, not just during periods of high inflation. Cochrane offers an extensive rethinking of monetary doctrines and institutions through the eyes of fiscal theory, and analyzes the era of zero interest rates and post-pandemic inflation. Filled with research by Cochrane and others, __The Fiscal Theory of the Price Level__ offers important new insights about fiscal and monetary policy. "Inflation, in which all prices and wages in an economy rise, is mysterious. If a war breaks out in the Middle East, and the price of oil goes up, the mechanism is no great mystery-supply and demand often work pretty visibly. But if you ask the grocer why the price of bread is higher, he or she will blame the wholesaler, who will blame the baker, who will blame the wheat supplier, and so on. Perhaps the ultimate cause is a government printing more money, but there is really no way to know this for certain but to sit down in an office with statistics, armed with some decent economic theory. But current economic theory doesn't really explain why we haven't seen inflation for so long, and more and more economists think that current theory doesn't hold together, or provide much guidance for how central banks should behave if inflation does break out. Many also worry that central banks have much less power over the economy than they think they do, and much less understanding of the mechanism behind what power they do have. The Fiscal Theory of the Price Level is a comprehensive new approach to monetary policy. Economist John Cochrane argues that money has value because the government accepts it for tax payments. This insight, he argues, leads to a deep re-reading of monetary policy and institutions. Inflation comes when a government is unable to repay its debts, rather than from mismanagement of the split of debt between money and bonds. In the book, he will analyze institutional design, historical episodes, and compare fiscal theory to the Keynesian and new-Keynesian theory based on interest rate targets, and to monetarism. The book offers an overview and introduction to the range of contemporary monetary economics and history of thought as well as the fiscal theory"-- Provided by publisher

A comprehensive account of how government deficits anddebt drive inflation Where do inflation and deflationultimately come from? The fiscal theory of the price level offers asimple answer: Prices adjust so that the real value of governmentdebt equals the present value of taxes less spending. Inflationbreaks out when people don't expect the government to fully repayits debts. The fiscal theory is well suited to today's economy:Financial innovation undermines money demand, and central banksdon't control the money supply or aggressively change interestrates, invalidating classic theories, while large debts anddeficits threaten inflation and constrain monetary policy. Thisbook presents a comprehensive account of this important theory fromone of its leading developers and advocates. John Cochrane aims tomake fiscal theory useful as a conceptual framework and modelingtool, and for analyzing history and policy. He merges fiscal theorywith standard models in which central banks set interest rates,giving a novel account of monetary policy. He generalizes thetheory to explain data and make realistic predictions. For example,inflation decreases in recessions despite deficits because discountrates fall, raising the value of debt; specifying that governmentspromise to partially repay debt avoids classic puzzles and allowsthe theory to apply at all times, not just during periods of highinflation. Cochrane offers an extensive rethinking of monetarydoctrines and institutions through the eyes of fiscal theory, andanalyzes the era of zero interest rates and post-pandemicinflation. Filled with research by Cochrane and others, TheFiscal Theory of the Price Level offers important new insightsabout fiscal and monetary policy.

Contents Preface Notation Part 1 The Fiscal Theory Introduction 1 A Two-PeriodModel 2 An IntertemporalModel 3 A Bit of Generality 4 Debt, Deficits, Discount Rates, and Inflation 5 Fiscal Theory in Sticky PriceModels 6 Fiscal Constraints 7 Long-Term Debt Dynamics Part II Assets, Rules, and Institutions 8 Assets and Choices 9 Better Rules 10 Balance Sheets and Pots of Assets Part III Monetary Doctrines, Institutions, and Some Histories 11 Monetary Policies 12 Interest Rate Targets 13 Monetary Institutions 14 Stories and Histories 15 Esthetics and Philosophy Part IV Money, Interest Rates, and Regimes 16 The New-Keynesian Model 17 Keynesian Models with Sticky Prices 18 History and Implications 19 Monetarism 20 The Zero Bound 21 The COVID-19 Inflation 22 Observational Equivalence Part V Past, Present, and Future 23 Past and Present 24 Tests,Models, and Applications 25 The Future Bibliography Index