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THE PRICE LEVEL: CONCLUDING COMMENTS

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In this paper, we find that post war data are inconsistent with the hypothesis that the US has been operating in a FD regime. Our VARs show that the liabilities to GDP ratio falls one period after an innovation in the surplus to GDP ratio. This response is consistent with a MD regime, in which a surplus pays off part of the debt.

It is inconsistent with a FD regime, unless innovations in the surplus to GDP ratio are negatively correlated with future surplus to GDP ratios or discount factors, and we find little or no evidence for such a correlation. We find some evidence of a change in fiscal regime that may have predated Reagan, but we find no evidence that the US switched to a FD regime. In summary, we find that the US has been in—and continues to be in—a MD regime.

In this paper, we used federal fiscal data for the entire post war period (1951-1995). Consolidated (federal, state and local) fiscal data are available from the OECD, but only for a relatively short period (1971-1995). In a companion piece, Canzoneri, Cumby and Diba (1997b), we find that the consolidated data for the United States produce results that are very similar to the ones we have just reported. Moreover, we find no convincing evidence in favor of the FD regime in any of the OECD countries we studied. However, the data sets are very short, and results for many of the countries were not very conclusive one way or the other. Further analysis of these countries may be warranted.

Our results do suggest that the empirical models developed at policy making institutions have been solved under the right assumptions. Or to put it in another way, our results provide support for more traditional views about price determination and monetary policy. The central bank can control the price level through demand management; the price level is not determined by the needs of fiscal solvency. Moreover, the traditional view of the “price indeterminacy problem” seems to be correct: the price level will not be pinned down when the central bank pegs the interest rate.