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The Fiscal Theory of the Price Level: Identifying Restrictions and Empirical Evidence

  • Luca Sala

This paper aims to test some implications of the fiscal theory of the price level (FTPL). We develop a model similar to Leeper (1991) and Woodford (1996), but extended so to generate real effects of fiscal policy also in the "Ricardian" regime, via an OLG demographic structure. We test on the data the predictions of the FTPL as incorporated in the model. We find that the US fiscal policy in the period 1960-1979 can be classified as "Non-Ricardian", while it is "Ricardian" since 1990. According to our analysis, the fiscal theory of the price level characterizes one phase of the post-war US history.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 257.

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Date of creation: 2004
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Handle: RePEc:igi:igierp:257
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  1. 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;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-99.
  2. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  3. Atsushi Inoue & Lutz Kilian, 2002. "Bootstrapping Smooth Functions of Slope Parameters and Innovation Variances in VAR (∞) Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(2), pages 309-332, May.
  4. Stephanie Schmitt-Grohé & Martín Uribe, 2007. "Optimal simple and implementable monetary and fiscal rules," FRB Atlanta Working Paper 2007-24, Federal Reserve Bank of Atlanta.
  5. Woodford, Michael, 2001. "Fiscal Requirements for Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 669-728, August.
  6. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  7. John H. Cochrane, 1998. "A Frictionless View of U.S. Inflation," NBER Working Papers 6646, National Bureau of Economic Research, Inc.
  8. 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.
  9. Woodford, Michael, 1994. "Monetary Policy and Price Level Determinacy in a Cash-in-Advance Economy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 345-80.
  10. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
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  12. Fabio Ghironi, 2000. "Towards New Open Economy Macroeconometrics," Boston College Working Papers in Economics 469, Boston College Department of Economics.
  13. Eric M. Leeper, 1989. "Policy rules, information and fiscal effects in a "Ricardian" model," International Finance Discussion Papers 360, Board of Governors of the Federal Reserve System (U.S.).
  14. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  15. Olivier Jean Blanchard & Philippe Weil, 1992. "Dynamic Efficiency, the Riskless Rate, and Debt Ponzi Games Under Uncertainty," NBER Working Papers 3992, National Bureau of Economic Research, Inc.
  16. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  17. Carlo A. Favero & Tommaso Monacelli, 2003. "Monetary-Fiscal Mix and Inflation Performance: Evidence from the U.S," Working Papers 234, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  18. Narayana R. Kocherlakota & Christopher Phelan, 1999. "Explaining the fiscal theory of the price level," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 14-23.
  19. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1329-1368.
  20. 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.
  21. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the Fiscal Theory of the Price Level," NBER Working Papers 7668, National Bureau of Economic Research, Inc.
  22. Frank Smets & Raf Wouters, 2002. "Openness, imperfect exchange rate pass-through and monetary policy," Working Paper Research 19, National Bank of Belgium.
  23. Henning Bohn, 1998. "The Behavior of U. S. Public Debt and Deficits," The Quarterly Journal of Economics, Oxford University Press, vol. 113(3), pages 949-963.
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