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P. Benigno: A Central Bank Theory of Price Level Determination

image-05/12/2017 - 11:18A theory in which the central bank controls the price level is put forward as an alternative to the fiscal theory of the price level. It is not necessary to have a fiscal stimulus to avoid liquidity traps nor a fiscal anchor to disallow inflationary spirals. A central bank appropriatley capitalized can succeed to control the price level by setting the interest rate on reserves, holding risk-free assets and rebating its income to the treasury - from which it has to maintain financial independence. If the central bank undertaked unconventional open-market operations, either it has to give up financial independence or leaves the economy exposed to self-fulfilling inflationary spirals or chronic liquidity traps. 

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