The book isn’t out yet, but I can’t help myself… A revised draft of Chapter 5, fiscal theory in sticky price models is up on my website here. Giving talks over the last year and writing some subsequent essays, I see clearer ways to present the sticky price models. Bottom line, these three graphs provide a nice capsule summary of what fiscal theory is all about:
Response of inflation, output and price level to a 1% deficit shock, with no change in interest rates. Bondholders lose from a long period of inflation above the nominal interest rate. Inflation goes away eventually on its own.
Response of inflation, output and price level to a permanent interest rate rise, with no change in fiscal policy, and sticky prices. The main line uses long-term debt. The omega=1 line uses roughly one year debt. The omega = infinity line uses instantaneous debt. Higher interest rates can temporarily lower inflation with long term debt. With short-term debt, despite sticky prices, inflation follows the interest rate exactly. Sticky prices do not imply sticky inflation.
I’ll keep updating as we go along. Comments and typos welcome.
And… there are still 4 days to go of the 30% discount at Princeton University Press. Use code P321.
Happy new year to all.