The fiscal theory of the price level is the idea that government
fiscal policy
In economics and political science, fiscal policy is the use of government revenue collection (taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variab ...
, including debt and taxes present and future, is the primary determinant of the
price level
The general price level is a hypothetical measure of overall prices for some set of goods and services (the consumer basket), in an economy or monetary union during a given interval (generally one day), normalized relative to some base set ...
or
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
as opposed to
monetary theory
Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing money and considers its functions (such as medium of exchange, store of value and unit of account), and it ...
. FTPL requires confidence the government will not default on its debts, but rather 'inflate away' debts. FTPL suggests that currency is like a stock in a government and if the government has
structural deficit then the 'stock' loses value.
Statement
In nominal terms, government must pay off its existing domestic liabilities (
government debt denominated in local currency units) either by
refinancing
Refinancing is the replacement of an existing debt obligation with another debt obligation under a different term and interest rate. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic ...
(rolling over the debt, issuing new debt to pay the old) or
amortizing (paying it off from surpluses in tax revenue). In real terms, a government can also inflate away the debt: if it causes or allows high inflation, the real amount it must repay will be smaller. Alternatively, it could default on its obligations.
The fiscal theory states that if a government has an unsustainable fiscal policy, such that it will not be able to pay off its obligation in future out of tax revenue (it runs a persistent
structural deficit), then it will pay them off via inflating the debt away. Thus, fiscal discipline, meaning a balanced budget over the course of the economic cycle is necessary for the price level to remain stable; unsustainable deficits will require inflation in future. For the price level to be stable (to control
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
), government finances must be sustainable: they must run a
balanced budget over the course of the
business cycle
Business cycles are intervals of Economic expansion, expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are ...
, meaning they must not run a
structural deficit.
Rubinomics suggests that balancing the budget reduces inflation and affects the price level. As such some see it as a form of fiscal theory of the price level.
History
The fiscal theory of the price level was developed primarily by
Eric M. Leeper (1991),
Christopher A. Sims
Christopher Albert Sims (born October 21, 1942) is an American econometrician and macroeconomist. He is currently the John J.F. Sherrerd '52 University Professor of Economics at Princeton University. Together with Thomas Sargent, he won the N ...
(1994), and
Michael Dean Woodford
Michael Dean Woodford (born 1955) is an American macroeconomist and monetary theorist who currently teaches at Columbia University.
Academic career
Woodford holds B.A. from the University of Chicago (1977) and a J.D. from Yale Law School (1980 ...
(1994, 1995, 2001). It has been criticized by
Narayana Kocherlakota
Narayana Rao Kocherlakota (born October 12, 1963) is an American economist and the Lionel W. McKenzie Professor of Economics at the University of Rochester. Previously, he served as the 12th president of the Federal Reserve Bank of Minneapolis u ...
and Christopher Phelan,
Willem Buiter
Willem Hendrik Buiter CBE (born 26 September 1949) is an American-British economist. He spent most of his career as an academic, teaching at various universities. More recently, he was Chief Economist at Citigroup.
Early life and education
Bu ...
(2002),
Bennett T. McCallum (1999, 2001, 2003), Oscar Arce, and Dirk Niepelt.
Further work has been done by
John H. Cochrane.
[ ]
See also
*
Modern Monetary Theory
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox
*
*
*
*
*
* macroeconomic theory that describes currency as a public monopoly and unemployment as evidence that a currency monopolist is overly restricting the supply of t ...
*
Fiscal discipline
A balanced budget (particularly that of a government) is a budget in which revenues are equal to expenditures. Thus, neither a budget deficit nor a budget surplus exists (the accounts "balance"). More generally, it is a budget that has no budge ...
References
Citations
Sources
*
Leonardo Auernheimer Leonardo Auernheimer (August 27, 1936 – 2010) was an economist, professor, and international monetary consultant. (Nicknamed "pepe").
Auernheimer was born in Argentina to Jose Ignacio Auernheimer and Maria Elena Savanti de Auernheimer. He gr ...
, "Monetary Policy Rules, the Fiscal Theory of the Price Level, and (Almost) All that Jazz," in Money, Crises, and Transition: Essays in Honor of Guillermo A. Calvo. Edited by Carmen M. Reinhart, Carlos A. Végh and Andrés Velasco, Cambridge, MA: MIT Press, 2008, pp. 41–67.
{{refend
Monetary economics
Theory of taxation
Fiscal policy
Government budgets
Business cycle theories