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The fallacy of the fiscal theory of the price level - one last time

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  • Buiter, Willem H.
  • Sibert, Anne C.

Abstract

There have been attempts to resurrect the fiscal theory of the price revel (FTPL). The original FTPL rests on a fundamental compounded fallacy: confusing the intertemporal budget constraint (IBC) of the State, holding with equality and with sovereign bonds priced at their contractual values, with a misspecified equilibrium nominal bond pricing equation, and the "double use" of this IBC. This fallacy generates a number of internal inconsistencies and anomalies. The issue is not an empirical one. Neither does it concern the realism of the assumptions. It is about flawed internal logic. The issue is not just of academic interest. If fiscal policy authorities were to take the FTPL seriously, costly policy accidents, including sovereign default and hyperinflation, could be the outcome. Interpreting the FTPL as an equilibrium selection mechanism in models with multiple equilibria does not help. Attempts by Sims to extend the FTPL to models with nominal price rigidities fail. The attempted resurrection of the FTPL fails. It is time to bury it again - for the last time.

Suggested Citation

  • Buiter, Willem H. & Sibert, Anne C., 2017. "The fallacy of the fiscal theory of the price level - one last time," Economics Discussion Papers 2017-84, Kiel Institute for the World Economy (IfW Kiel).
    • Handle: RePEc:zbw:ifwedp:201784
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    Cited by:

    1. Narayana R. Kocherlakota, 2020. "21st Century Macro," NBER Working Papers 26791, National Bureau of Economic Research, Inc.
    2. Buiter, Willem H. & Sibert, Anne C., 2018. "The fallacy of the fiscal theory of the price level: One last time," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 12, pages 1-56.
    3. Willem Hendrik Buiter, 2023. "The Fiscal Theory of the Price Level," The Economic Record, The Economic Society of Australia, vol. 99(327), pages 568-572, December.
    4. Hannes Malmberg & Erik Öberg, 2021. "Price‐Level Determination When Tax Payments Are Required in Money," Scandinavian Journal of Economics, Wiley Blackwell, vol. 123(2), pages 621-644, April.
    5. Olivo, Victor, 2023. "Show Me the Money. Why Neglecting Money in Monetary Theory and Policy is a Bad Idea," MPRA Paper 118993, University Library of Munich, Germany, revised 27 Oct 2023.
    6. Bossone, Biagio, 2019. "The portfolio theory of inflation (and policy effectiveness)," Economics Discussion Papers 2019-29, Kiel Institute for the World Economy (IfW Kiel).

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    More about this item

    Keywords

    fiscal theory of the price level; intertemporal budget constraint; equilibrium bond pricing equation; monetary and fiscal policy coordination; equilibrium selection; fiscal dominance;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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