How to Teach Fiscal-Monetary Policy Interactions to Advanced Undergraduate Students

This paper proposes a systematic approach to the teaching of fiscal-monetary interactions that follows the view of one of the fathers of the Fiscal Price Level Theory (TFP), Eric Leeper. The main advantage of this approach is its simplicity, which makes it particularly suitable for undergraduate students and non-specialists. It relies on a two-graph device to show that fiscal and monetary policies are always determined simultaneously and that their effects on the economy always depend on each other’s behavior. It is straightforward to see that in a conventional monetarist world (Regime M), the central bank manages to control inflation as long as the fiscal authority does its job of ensuring that government debt does not grow too much. By contrast, in an alternative fiscally dominant regime (Regime F), fiscal policy determines the price level (and inflation) in the short run, and the optimal monetary stance is to keep the policy rate constant, since, if the central bank tries to fight fiscally determined inflation, it will worsen fiscal sustainability and increase future inflation. Thus, banishing from the minds of economics graduates in Spanish universities the idea that, in normal times, fiscal and monetary policies have independent effects on economic activity is of vital importance and it is one of the main objectives of our work. As a fundamental complement to our model, an exercise of practical implementation of our proposal within the Spanish University System is carried out, discussing how it would be adapted to the curricula designed at national level, and providing concrete information, to potential teachers interested in its future use, on the probable reaction of the students and their degree of learning/performance.