DP13432 The Fiscal Theory of the Price Level in Overlapping Generations Models

Author(s): Roger E A Farmer, Pawel Zabczyk
Publication Date: January 2019
Keyword(s): FTPL, Indeterminacy, Monetary and Fiscal Policy, monetary policy, OLG model
JEL(s): E31, E52, E58, H62
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13432

We demonstrate that the Fiscal Theory of the Price Level (FTPL) cannot be used to determine the price level uniquely in the overlapping generations (OLG) model. We provide two examples of OLG models, one with three 3-period lives and one with 62-period lives. Both examples are calibrated to an income profile chosen to match the life-cycle earnings process in U.S. data estimated by Guvenen et al. (2015). In both examples, there exist multiple steady-state equilibria. Our findings challenge established views about what constitutes a good combination of fiscal and monetary policies. As long as the primary deficit or the primary surplus is not too large, the fiscal authority can conduct policies that are unresponsive to endogenous changes in the level of its outstanding debt. Monetary and fiscal policy can both be active at the same time.