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The Fiscal Theory of the Price Level - identification and testing for the UK in the 1970s

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Abstract

We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model,the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the Orthodox model outperforms the FTPL. But the best account of the period assumes that expectations were a probability-weighted combination of the two regimes.

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  • Fan, Jingwen & Minford, Patrick & Ou, Zhirong, 2013. "The Fiscal Theory of the Price Level - identification and testing for the UK in the 1970s," Cardiff Economics Working Papers E2013/12, Cardiff University, Cardiff Business School, Economics Section.
  • Handle: RePEc:cdf:wpaper:2013/12
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    Keywords

    UK Inflation; Fiscal Theory of the Price Level; Identification; Testing; Indirect inference;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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