Price level determinacy and monetary policy under a balanced-budget requirement

This paper analyzes the implications of a balanced-budget fiscal policy rul e for price-level determination in a cash-in-advance economy under three al ternative monetary policy regimes. It shows that the price level is indeter minate under a nominal interest rate peg and determinate under a money grow th rate peg. Under a feedback rule that sets the nominal interest rate as a non-negative and non-decreasing function of the inflation rate, the price level is indeterminate for both low and high values of the inflation elasti city of the feedback rule and determinate for intermediate values. We also study balanced-budget rules that allow for bounded secondary surpluses or d eficits. Comparing our results to those emphasized in the fiscal theory of the price level, it becomes clear that a key consideration for price-level determination is whether fiscal policy is specified as an exogenous sequenc e of primary surpluses/deficits or, alternatively, as an exogenous sequence of secondary surpluses/deficits. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification:E63; E52; E31.