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The fallacy of the fiscal theory of the price level, again

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  • Willem H. Buiter

Abstract

This paper argues that the 'fiscal theory of the price level' (FTPL) is fallacious. The source of the fallacy is an elementary economic misspecification. The FTPL denies a fundamental property of any model of a market economy, that the budget constraint of any agent, private or public, must be satisfied identically, ie for all admissible values of the variables entering the budget constraint. Instead the FTPL requires the government's inter-temporal budget constraint to be satisfied only in equilibrium. The FTPL looks for equilibria in which the government can meet its contractual debt obligations exactly, despite having an overdetermined financial-fiscal monetary programme. The economic misspecification has implications for the mathematical properties of the equilibria supported by models that impose the structure of the FTPL. For example, the FTPL implies the anomaly that it can price money in an economy without money. The FTPL has an exact analogue in a 'household budget constraint theory of the price level', which is perhaps more readily recognised as a nonsense.

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Paper provided by Bank of England in its series Bank of England working papers with number 141.

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Date of creation: Jul 2001
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Handle: RePEc:boe:boeewp:141

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  1. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  2. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, Springer, vol. 4(3), pages 345-80.
  3. Maurice Obstfeld & Kenneth Rogoff, 1982. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," NBER Working Papers 0855, National Bureau of Economic Research, Inc.
  4. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 43(1), pages 1-46, December.
  5. Michael Woodford, 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," NBER Working Papers 6188, National Bureau of Economic Research, Inc.
  6. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1772, C.E.P.R. Discussion Papers.
  7. John H. Cochrane, 1999. "A Frictionless View of U.S. Inflation," NBER Chapters, in: NBER Macroeconomics Annual 1998, volume 13, pages 323-421 National Bureau of Economic Research, Inc.
  8. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 27(1), pages 129-147, February.
  9. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(3), pages 613-630, June.
  10. Bennett T. McCallum, . "Indeterminacy, Bubbles, and the Fiscal Theory of Price Level Determination," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1998-19, Carnegie Mellon University, Tepper School of Business.
  11. Norbert Janssen & Charles Nolan & Ryland Thomas, 2004. "Money, Debt and Prices in the UK 1705-1996," CDMA Working Paper Series, Centre for Dynamic Macroeconomic Analysis 200407, Centre for Dynamic Macroeconomic Analysis.
  12. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall.
  13. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262150476, December.
  14. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," NBER Working Papers 6771, National Bureau of Economic Research, Inc.
  15. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, Elsevier, vol. 10(3), pages 335-359.
  16. John H. Cochrane, 2000. "Money as Stock: Price Level Determination with no Money Demand," NBER Working Papers 7498, National Bureau of Economic Research, Inc.
  17. Buiter, Willem H, 1987. "A Fiscal Theory of Hyperdeflations? Some Surprising Monetarist Arithmetic," Oxford Economic Papers, Oxford University Press, vol. 39(1), pages 111-18, March.
  18. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer, Springer, vol. 4(3), pages 381-99.
  19. Obstfeld, Maurice & Rogoff, Kenneth, 1986. "Ruling out divergent speculative bubbles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 17(3), pages 349-362, May.
  20. Buiter, Willem H, 1998. "The Young Person's Guide to Neutrality, Price Level Indeterminacy, Interest Rate Pegs and Fiscal Theories of the Price Level," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1799, C.E.P.R. Discussion Papers.
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Citations

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Cited by:
  1. Jerome Creel & Henri Sterdyniak, 2000. "La théorie budgétaire du niveau des prix : un bilan critique (The Fiscal Theory of the Price Level, a critical assessment) (in French with English summary)," Documents de Travail de l'OFCE, Observatoire Francais des Conjonctures Economiques (OFCE) 2000-03, Observatoire Francais des Conjonctures Economiques (OFCE).
  2. repec:spo:wpecon:info:hdl:2441/5122 is not listed on IDEAS
  3. Jérôme Creel & Henri Sterdyniak, 2000. "La théorie budgétaire du niveau des prix, un bilan critique," Sciences Po publications 2000-03, Sciences Po.
  4. Óscar J. Arce, 2005. "Reflections on fiscalist divergent price-paths," Banco de Espa�a Working Papers 0533, Banco de Espa�a.
  5. Bajo-Rubio, Oscar & Díaz-Roldán, Carmen & Esteve, Vicente, 2009. "Deficit sustainability and inflation in EMU: An analysis from the Fiscal Theory of the Price Level," European Journal of Political Economy, Elsevier, vol. 25(4), pages 525-539, December.
  6. Jérôme Creel, 2002. "Strategic interactions between monetary and fiscal policies: a case study for the European Stability Pact," Sciences Po publications info:hdl:2441/3221, Sciences Po.
  7. António Afonso, 2002. "Disturbing the Fiscal Theory of the Price Level: Can it Fit the EU-15," Working Papers Department of Economics, ISEG - School of Economics and Management, Department of Economics, University of Lisbon 2002/01, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  8. Guillard, Michel & Sosa Navarro, Ramiro, 2009. "Fiscal Imbalances, Inflation and Sovereign Default Dynamics," MPRA Paper 24075, University Library of Munich, Germany.

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