ABSTRACT: Hyperinflation is usually interpreted as a result of the monetary financing of serious fiscal imbalances. Here, a fiscalist alternative is explored, in which inflation explodes because of the fiscal effects of monetary policy. Higher interest rates cause the outside financial wealth of private agents to grow faster in nominal terms, which in fiscalist models calls for higher inflation. If the monetary authority responds to higher inflation with sufficiently higher nominal interest rates, a vicious circle is formed. The model is particularly advantageous for hyperinflations in which most of the fiscal action concentrates in the interest bill on public debt and debt rollover, rather than seigniorage or primary budget deficits. Brazil in the late 1970s and early 1980s serves as a motivating case. (JEL E31, E5) Inflation – so goes the monetarist dictum – is always and everywhere a monetary phenomenon. Of course, there is no conflict between that claim and monetary expansion ultimately originating in the need to finance fiscal deficits. Nowhere is that as distinct as in studies of hyperinflation in the tradition of Phillip Cagan (1956). Adopting the fiscalist approach to price determination advocated by Eric M. Leeper (1991), Christopher A. Sims (1994) and Michael Woodford (1994, 1995), one can turn that monetarist story right on its head. In a fiscalist world, prices are driven not by liquidity, but by the outside wealth of private agents. Budget deficits, under a fiscal policy regime that causes a

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 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...

fallacy of the fiscal theory