A Central Bank Theory of Price Level Determination

A theory in which the central bank controls the price level is put forward as an alternative to the …scal theory of the price level. It is not necessary to have a …scal stimulus to avoid liquidity traps nor a …scal anchor to disallow in‡ationary spirals. A central bank appropriately 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 …nancial independence. If the central bank undertakes unconventional open-market operations, either it has to give up its …nancial independence or leaves the economy exposed to self-ful…lling in‡ationary spirals or chronic liquidity traps.