Price-level determination, the zero lower bound on the interest rate and optimal monetary policy (Norway)

The first chapter investigates whether fiscal policy determines the price level in Norway. According to the ‘fiscal theory of price-level determination’, the price level may be determined by fiscal policy if a ‘non-Ricardian’ regime is present. Norwegian public revenues are influenced by the oil price via its effect on public income from the petroleum sector. The response in the real value of public debt to an innovation in the oil-price calculated from a VAR is zero. Furthermore, real debt does not seem to Granger cause the oil price. I interpret this to indicate that fiscal policy does not determine the price level and the regime is ‘Ricardian’. Possible nonstationarity in the data makes the empirical evidence unclear.; Chapter two is coauthored with Dale Henderson. We use a flexible-price perfect-foresight model to study the existence of multiple equilibria for the inflation rate, including liquidity traps where the inflation rate and nominal interest rate are at their lower bounds. Such low-inflation equilibria have been shown to exist in addition to the authorities' inflation target, given a lower bound on the interest rate. We show that a balanced-budget rule may not be enough to rule out liquidity-trap equilibria. We suggest monetary policy rules that are associated with uniqueness. One is an interest rate rule where the interest rate responds stronger to future inflation if current inflation is below target than if it is above target.; The third chapter analyzes optimal monetary policy in a sticky price model when there is a lower bound on the nominal interest rate. The first-best solution is achieved with an interest-rate rule that makes the inflation rate move with the natural interest rate. The nominal interest rate should be close to zero to minimize money-demand distortions. The non-optimality of stabilizing the inflation rate is in contrast to some recent literature on optimal monetary policy. If authorities choose to stabilize inflation, there is a trade-off between average inflation and output stabilization. With more elastic money demand or less variable productivity, average inflation should be relatively low.