DP11966 A Central Bank Theory of Price Level Determination

Author(s): Pierpaolo Benigno
Publication Date: April 2017
Keyword(s):
JEL(s):
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11966

A theory in which the central bank controls the price level is put forward as an alternative to the fiscal theory of the price level. It is not necessary to have a fiscal stimulus to avoid liquidity traps nor a fiscal anchor to disallow inflationary spirals. A central bank appropriately capitalized can succeed to control the price level by setting the interest rate on reserves, holding risk-free assets and rebating its income to the treasury -- from which it has to maintain financial independence. If the central bank undertakes unconventional open-market operations, either it has to give up its financial independence or leaves the economy exposed to self-fulfilling inflationary spirals or chronic liquidity traps.