The Fiscal Myth of the Price Level
I examine the "fiscal theory of the price level" according to which "non-Ricardian" policy and predetermined nominal government debt fiscally determine prices. I argue that the non-Ricardian policy assumption and, by implication, fiscal price level determination are inconsistent with a rational expectations equilibrium where all asset holdings reflect optimal household choices. In such a rational expectations equilibrium, policy must be Ricardian even if, in some states of nature, the government defaults or runs an exogenous real primary surplus sequence. I propose an alternative to the fiscal theory of the price level, based on nominal flows instead of nominal stocks. While this alternative framework establishes a consistent link between fiscal policy and the price level, it does not introduce inflationary fiscal effects beyond those suggested by Sargent and Wallace.
|Date of creation:||16 May 2002|
|Date of revision:|
|Publication status:||Published in Quartely Journal of Economics, 2004, pages 277-300.|
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