Article2002

The Fiscal Theory of the Price Level: A Critique

280 citations0/0 files storedThe Economic Journal

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Economic theories and models Monetary Policy and Economic Impact Economic Theory and Policy

Abstract

This paper argues that the ‘fiscal theory of the price level' (FTPL) has feet of clay. The source of the problem is a fundamental economic misspecification. The FTPL confuses two key building blocks of a model of a market economy: budget constraints, which must be satisfied identically, and market clearing or equilibrium conditions. The FTPL asssumes that the government's intertemporal budget constraint needs to be satisfied only in equilibrium. This economic misspecification has far‐reaching implications for the mathematical properties of the equilibria supported by models that impose the structure of the FTPL. It produces a rash of contradictions and anomalies.

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References

1997Foundations of International Macroeconomics 1991Equilibria under ‘active’ and ‘passive’ monetary and fiscal policies 1984Some Unpleasant Monetarist Arithmetic 1982Interest rates and currency prices in a two-country world 1994A simple model for study of the determination of the price level and the interaction of monetary and fiscal policy 1967A RECONSIDERATION OF THE MICROFOUNDATIONS OF MONETARY THEORY 1994Monetary policy and price level determinacy in a cash-in-advance economy 1995Price-level determinacy without control of a monetary aggregate

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