Is the Price Level Determined by the Needs of Fiscal Solvency?

Abstract

The fiscal theory of price determination suggests that if primary surpluses evolve independently of government debt, the equilibrium price level "jumps" to assure fiscal solvency. In this non-Ricardian regime, fiscal policy--not monetary policy--provides the nominal anchor. Alternatively, in a Ricardian regime, primary surpluses are expected to respond to debt in a way that assures fiscal solvency, and the price level is determined in conventional ways. This paper argues that Ricardian regimes are as theoretically plausible as non-Ricardian regimes, and provide a more plausible interpretation of certain aspects of the postwar U.S. data than do non-Ricardian regimes.

Deficit sustainability and inflation in EMU: An analysis from the Fiscal Theory of the Price Level

“…The first contributions, both of them for the case of the US economy, were those of Bohn (1998) and Canzoneri, Cumby and Diba (2001), who pioneered the two main approaches employed to test for the FTPL, namely, the so-called backward-looking and forwardlooking approaches, respectively. So, Bohn (1998) obtains, by means of econometric techniques, a positive response of the primary surplus-to-GDP ratio to the (lagged) debtto-GDP ratio.…”

“…So, Bohn (1998) obtains, by means of econometric techniques, a positive response of the primary surplus-to-GDP ratio to the (lagged) debtto-GDP ratio. In turn, making use of VAR analysis, Canzoneri, Cumby and Diba (2001) find that a positive innovation in the primary surplus would cause a fall in debt. Accordingly, the results of both studies would not support the existence of fiscal dominance.…”

“…The first one was by Mélitz (2000), who shows that fiscal policy would have responded in a stabilizing manner to changes in the debt-to-GDP ratio for the EU-15 countries. Later on, Ballabriga and Martínez-Mongay (2003) estimate monetary and fiscal rules for the euro area, and conclude that the MD regime would have prevailed in these countries throughout the years before the formation of EMU (1979EMU ( -1998 (2006) confirm for France, Germany, Italy and the UK, both using the primary surplus and its two separate components (cyclical and structural), the conclusions of Canzoneri, Cumby and Diba (2001), so that a MD regime would also apply to the experience of these countries.…”

Sustainability of US public debt: Estimating smoothing spline regressions

“…This is the major idea behind fitting additive models and we refer to Hastie & Tibshirani (1990) Table 3: Parametric estimates for model (2) using the data as shown in Figure 1 excluding 1916-1919 and 1940-1946. …”

“…Formally, this was proven by Bohn (1998) assuming a constant reaction coefficient. Canzonerie et al (2001) generalized the proof by allowing for a time dependent reaction coefficient. 1 For the US, Bohn (1998) estimated OLS regressions and found that the primary surplus-GDP ratio is a positive function of the debt ratio implying that US debt policy is sustainable.…”