Fiscal Requirements for Price Stability

Maintaining price stability requires not only commitment to an appropriate monetary policy rule, but an appropriate fiscal policy rule as well. Ricardian equivalence does not imply that fiscal policy is irrelevant, except in the case of a certain class of policies (“Ricardian” policies). The role of fiscal developments in inflation determination under a non-Ricardian regime is illustrated through an analysis of the bond-price support regime of the 1940s. A monetary-fiscal regime with attractive properties would combine a “Taylor rule” for monetary policy with nominal-deficit targeting as a fiscal policy commitment. ∗Official text of the 2000 Money, Credit and Banking Lecture, presented at Ohio State University on May 1, 2000. I wish to thank Michael Bordo, Matt Canzoneri, Steve Cecchetti, Larry Christiano, John Cochrane, Paul Evans, Eduardo Loyo, Bennett McCallum, Hélène Rey, Stephanie Schmitt-Grohé and Chris Sims for helpful discussions, Gauti Eggertsson for research assistance, and the National Science Foundation for research support through a grant to the NBER. “Proposals for a monetary rule require a supplementary proposal of a fiscal rule.” Karl Brunner (1986), p. 54.