 Does the Fiscal Theory of the Price Level help to explain the US economy?Vo Phuong Mai Le, A. Patrick Minford, David Meenagh and Michael Wickens No E2024/17, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section Abstract: We implement a quantitative empirical test of FTPL defined as a non-Ricardian model of fiscal policy (the ‘FTPL model’). We used Indirect Inference to compare its match to postwar US data with that of a standard New Keynesian model with Ricardian fiscal policy. The distinguishing feature of this FTPL version of the orthodox New Keynesian model is that government spending and taxation are allowed to evolve according to data-based exogenous processes. Nominal debt accumulates according to the government’s budget constraint and at a future date, T, this accumulated nominal debt must be devalued to a sustainable real level by a terminal price level, which in turn defines an average inflation rate to that point from the pre-regime price level. This rate determines expected inflation which then enters the model up to the terminal date. Thus inflation is caused by expected fiscal policy. During this FTPL regime monetary policy has a weak (less than unity) interest rate response to inflation. The FTPL regime is expected to end at T and be replaced then by a Ricardian New Keynesian (orthodox) regime which will generate primary surpluses that back the resulting real debt at T. While this hypothesised FTPL regime was rejected over the whole postwar sample, it was accepted for the post-GFC period alone, with the orthodox regime prevailing otherwise; this regime combination was as probable an explanation of the whole period as the orthodox regime alone. Nevertheless, a more probable model was the New Keynesian model with an orthodox monetary regime throughout and a fiscal regime whose Ricardian commitment was limited by the debt-related probability of a future switch to the FTPL. This model provided the best-fitting explanation of the whole period. This gives a key role to the FTPL in explaining postwar US behaviour through its continuous debt-related effect on the credibility of the fiscal Ricardian commitment. Pages: 23 pages Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cdf:wpaper:2024/17 Access Statistics for this paper More papers in Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section Contact information at EDIRC. |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.