Does the Fiscal Theory of the Price Level Help to Explain the US Economy?

Vo Phuong Mai Le, David Meenagh, Patrick Minford and Michael R. Wickens

No 20597, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We implement a quantitative empirical test of the fiscal theory, FTPL, defined as a non-Ricardian model of fiscal policy (the 'FTPL model') in which accumulated debt is ultimately devalued by a rising price level. Thus inflation is caused by expected fiscal policy. We used indirect inference to compare its match to postwar US data with that of a standard New Keynesian model with Ricardian fiscal policy. This FTPL model is first treated as a permanent regime, expected throughout the postwar period, with equilibrating real interest rates set by monetary policy; we also repeated this within a classical RBC model with market-clearing real interest rates. In both cases we found that there was no stable solution, due to the 'doom loop' linking debt, interest rates and inflation. We then modelled FTPL as a temporary regime including a monetary policy with a weak response to inflation, expected to revert to the Ricardian New Keynesian (Orthodox) regime eventually. While this hypothesis was rejected over the whole postwar sample, it was accepted for the post-GFC period alone, with the Orthodox regime prevailing otherwise. However the model fitting the whole period best was the New Keynesian with an orthodox monetary regime and a fiscal regime the credibility of whose Ricardian commitment was limited by the debt-related probability of a future switch to the FTPL. This gives a key role to the FTPL in explaining postwar US behaviour.

JEL-codes: E31 E61 E62 E63 (search for similar items in EconPapers)
Date: 2025-08
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP20597 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:20597

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP20597

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().