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3 A country's consolidated government budget constraint in period t is defined as: Pigt + Bi-1 = Ti + PpB: + Me - Mi-1 Where
3 A country's consolidated government budget constraint in period t is defined as: Pigt + Bi-1 = Ti + PpB: + Me - Mi-1 Where g is government spending, B denotes bonds held by the private sector, p is the price of bonds, 7 denotes taxation and M the money supply. The consumer price index is denoted by P. (a) Use the consolidated government budget constraint to derive an intertem- poral government budget constraint. (5 marks) (b) In your own words, explain the fiscal theory of the price level. What is the macroeconomic mechanism that allows prices to rise without expected or (c) In your own words, explain the fiscal theory of inflation. Does the fiscal theory of inflation imply that central banks can never be truly independent? (14 marks)
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