Maintaining price stability requires not only commitment to an appropriate monetary policy rule, but an appropriate fiscal policy rule as well. Ricardian equivalence does not imply that fiscal policy is irrelevant, except in the case of a certain class of policies ("Ricardian" policies). The role of fiscal developments in inflation determination under a non-Ricardian regime is illustrated through an analysis of the bond-price support regime of the 1940s. A monetary-fiscal regime with attractive properties would combine a "Taylor rule" for monetary policy with nominal-deficit targeting as a fiscal policy commitment. # O#cial text of the 2000 Money, Credit and Banking Lecture, presented at Ohio State University on May 1, 2000. I wish to thank Michael Bordo, Matt Canzoneri, Steve Cecchetti, Larry Christiano, John Cochrane, Paul Evans, Eduardo Loyo, Bennett McCallum, Helene Rey, Stephanie Schmitt-Grohe and Chris Sims for helpful discussions, Gauti Eggertsson for research assistance...

ABSTRACT __________________________________________________________________________ The goal of this paper is to probe the validity of the fiscal theory of the price level by modeling explicitly the market structure in which households and the governments make their decisions. I describe the economy as a game, and I am thus able to state precisely the consequences of actions that are out of the equilibrium path. I show that there exist government strategies that lead to a version of the fiscal theory, in which the price level is determined by fiscal variables alone. However, these strategies are more complex than the simple budgetary rules usually associated with the fiscal theory, and the government budget constraint cannot be merely viewed as an equilibrium condition.

The views and opinions expressed are those of the author only. They do not necessarily reflect the views and opinions of the Bank of England or of the other members of the Monetary Policy Committee.

This paper applies the fiscal theory of price level determination to the case of a monetary union. A fiscal perspective suggests, first, that the focus of past studies on seigniorage, per se, may be misplaced. Second, a rise in the level of debt by one member government can raise the common price level throughout the union, suggesting a role for fiscal rules. Third, conditions are discussed under which fiscal solvency is not necessary for each member government in a monetary union. Key words: monetary union, fiscal theory of the price level, fiscal rules

Many traditional macroeconomic models do not have determinate predictions for the path of inflation: even for a given specification of money supplies, many paths of inflation are consistent with equilibrium. According to the fiscal theory of the price level, fiscal policy can be used to select which of these many paths actually occur. This article explains the fiscal theory of the price level and discusses its empirical and policy implications. The article argues that the theory is equivalent to giving the government an ability to choose among equilibria. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. How can governments influence inflation rates? Economists’ standard answer is that the central bank controls the inflation rate through its ability to control the money supply. In particular, if output grows at γ percent per year and the money supply grows at µ percent per year, then, at least over sufficiently long periods of time,

This paper considers whether monetary and fiscal policy may sensibly be formulated independently of one another, and argues that the reasons for the two to be interconnected go well beyond the familiar but unappealing possibility of using seignorage as a source of revenue for the government. Particular attention is given to the e#ects of fiscal policy upon the price level through the wealth e#ect of variations in the value of the public debt; such e#ects are shown to be consistent with rational expectations and frictionless financial markets, contrary to the doctrine of "Ricardian equivalence", in the case of "non-Ricardian" fiscal policy. In this case, the e#ects of variation in the composition of the public debt (as to maturity and degree of indexation) are considered, as well as the e#ects of growth in its overall size. A number of objections to the possibility of a non-Ricardian policy are considered, notably the assertions that it is not possible for a government to ref...

This paper argues that the `fiscal theory or the price level' (FTPL), developed by Woodford, Cochrane, Sims and others, is a fallacy. The source of the fallacy is an elementary economic misspecification. The FTPL denies a fundamental property of any model of a market economy, that the budget constraint of any agent, private or public, must be satisfied identically, that is, for all admissible values of the variables entering the budget constraint. Instead the FTPL requires the government's intertemporal budget constraint to be satisfied only in equilibrium. The FTPL looks for equilibria in which the government can meet its contractual debt obligations exactly, despite having an overdetermined fiscalfinancial -monetary programme. The economic misspecification has implications for the mathematical properties of the equilibria supported by models that impose the structure of the FTPL. Under many circumstances, the FTPL must be `switched off' for no good economic reason if contradiction...

We consider price level determination from the perspective of portfolio choice. Arbitrages among money balances, bonds, and investment goods determine their relative demands. Returns to real balance holdings (transactions services), the nominal interest rate, and after-tax returns to investment goods determine the relative values of nominal and real assets. Since expectations of government policies ultimately determine the expected returns to both nominal and real assets, monetary and fiscal policies jointly determine the price level. Special cases of the fiscal and monetary policies considered produce the quantity theory of money and the fiscal theory of the price level.

from detailed comments of an anonymous referee and of the editorial board, for which I am indebted.The responsibility for any errors is mine only.This paper has been prepared while I was visiting the ECB in the context of an internship program in the Fiscal Policies Division whose hospitality is gratefully acknowledged.The opinions expressed herein are

Monetary policy decisions tend to be based on systematic analysis of alternative policy choices and their associated macroeconomic impacts: this is science. Fiscal policy choices, in contrast, spring from unsystematic speculation, grounded more in politics than economics: this is alchemy. In normal times, fiscal alchemy poses no insurmountable problems for monetary policy because fiscal expectations can be extrapolated from past fiscal behavior. But normal times may be coming to an end: aging populations are causing promised government old-age benefits to grow relentlessly and many governments have no plans for financing the benefits. In this era of fiscal stress, fiscal expectations are unanchored and fiscal alchemy creates unnecessary uncertainty and can undermine the ability of monetary policy to control inflation and influence real economic activity in the usual ways.