Policy Choices Under Monetary and Fiscal Theories of the Price Level

Price-level determination requires co-ordination of monetary and Öscal policy

to ensure a unique rational expectations equilibrium (REE). This paper derives

a number of implications for simple interest rate rules resulting from various

Öscal strategies. We show that Öscal choices under either the monetary theory

of the price-level (MTPL) and the Öscal theory of the price-level (FTPL) can

challenge widely accepted principles of monetary policy. SpeciÖcally, we show

that a Öscal rule that responds aggressively to output and ináation may force the

monetary authorities to adopt signiÖcantly more aggressive output and ináation

stabilization policy than suggested by the Taylor Principle. We also show how

when monetary policy is severely constrained, the Öscal policy maker can act to

stabilise the economy. Some policy conclusions in light of the lower zero bound for

monetary policy and debt stabilization are drawn.