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

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Willem H. Buiter

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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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Handle: RePEc:boe:boeewp:141

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," CRSP working papers 479, Center for Research in Security Prices, Graduate School of Business, University of Chicago. [Downloadable!]
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  3. 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. [Downloadable!] (restricted)
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  4. 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.
  5. Norbert Janssen & Charles Nolan & Ryland Thomas, 2004. " Money, Debt and Prices in the UK 1705-1996," CDMA Working Paper Series 0407, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
  6. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 1998. "Is the Price Level Determined by the Needs of Fiscal Solvency?," NBER Working Papers 6471, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. 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. [Downloadable!] (restricted)
  8. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January. [Downloadable!] (restricted)
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  9. John H. Cochrane, 2000. "Money as Stock: Price Level Determination with no Money Demand," NBER Working Papers 7498, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. John H. Cochrane, 1998. "Long-term Debt and Optimal Policy in the Fiscal Theory of the Price Level," CRSP working papers 478, Center for Research in Security Prices, Graduate School of Business, University of Chicago. [Downloadable!]
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  11. Obstfeld, Maurice & Rogoff, Kenneth, 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 675-87, August. [Downloadable!] (restricted)
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  12. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall. [Downloadable!]
  13. 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. [Downloadable!] (restricted)
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  14. Michael Woodford, 1995. "Price Level Determinacy Without Control of a Monetary Aggregate," NBER Working Papers 5204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer, vol. 4(3), pages 345-80.
  17. Bennett T. McCallum, 1998. "Indeterminacy, Bubbles, and the Fiscal Theory of Price Level Determination," NBER Working Papers 6456, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  18. Obstfeld, Maurice & Rogoff, Kenneth, 1986. "Ruling out divergent speculative bubbles," Journal of Monetary Economics, Elsevier, vol. 17(3), pages 349-362, May. [Downloadable!] (restricted)
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Cited by:
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  1. Óscar J. Arce, 2005. "Reflections on fiscalist divergent price-paths," Banco de España Working Papers 0533, Banco de España. [Downloadable!]
  2. 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). [Downloadable!]
  3. António Afonso, 2002. "Disturbing the Fiscal Theory of the Price Level: Can it Fit the EU-15," Working Papers 2002/01, Department of Economics at the School of Economics and Management (ISEG), Technical University of Lisbon.. [Downloadable!]
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