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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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Bibliographic Info

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. McCallum, Bennett T., 2001. "Indeterminacy, bubbles, and the fiscal theory of price level determination," Journal of Monetary Economics, Elsevier, vol. 47(1), pages 19-30, February.
  2. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," NBER Working Papers 6646, National Bureau of Economic Research, Inc.
  3. Obstfeld, Maurice & Rogoff, Kenneth, 1986. "Ruling out divergent speculative bubbles," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 349-362, May.
  4. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  5. 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 1799, C.E.P.R. Discussion Papers.
  6. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  7. Maurice Obstfeld & Kenneth Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
  8. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  9. 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.
  10. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  11. Woodford, Michael, 1997. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Seminar Papers 632, Stockholm University, Institute for International Economic Studies.
  12. Norbert Janssen & Charles Nolan & Ryland Thomas, 2004. "Money, Debt and Prices in the UK 1705-1996," CDMA Working Paper Series 200407, Centre for Dynamic Macroeconomic Analysis.
  13. Canzoneri, Matthew B & Cumby, Robert & Diba, Behzad, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," CEPR Discussion Papers 1772, C.E.P.R. Discussion Papers.
  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. Woodford, Michael, 1995. "Price-level determinacy without control of a monetary aggregate," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 43(1), pages 1-46, December.
  16. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  17. John H. Cochrane, 2000. "Money as Stock: Price Level Determination with no Money Demand," NBER Working Papers 7498, National Bureau of Economic Research, Inc.
  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, vol. 4(3), pages 381-99.
  19. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  20. Dupor, Bill, 2000. "Exchange rates and the fiscal theory of the price level," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 613-630, June.
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Cited by:
  1. Oscar Bajo-Rubio & Carmen Díaz-Roldán & Vicente Esteve, 2007. "Deficit sustainability and inflation in EMU: An analysis from the fiscal theory of the price level," Working Papers 07-01, Asociación Española de Economía y Finanzas Internacionales.
  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. António Afonso, 2002. "Disturbing the Fiscal Theory of the Price Level: Can it Fit the EU-15," Working Papers Department of Economics 2002/01, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  5. 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.
  6. Óscar J. Arce, 2005. "Reflections on fiscalist divergent price-paths," Banco de Espa�a Working Papers 0533, Banco de Espa�a.
  7. Guillard, Michel & Sosa Navarro, Ramiro, 2009. "Fiscal Imbalances, Inflation and Sovereign Default Dynamics," MPRA Paper 24075, University Library of Munich, Germany.
  8. 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 2000-03, Observatoire Francais des Conjonctures Economiques (OFCE).

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