A requiem for the Fiscal Theory of the Price Level
The Fiscal Theory of the Price Level (FTPL) is the claim that, in a popular class of theoretical models, the price level is sometimes determined by fiscal policy rather than monetary policy. The FTPL argument is made within the context of an infinitely-lived, representative agent. In this paper, Farmer and Zabczyk use a sixty-two generation overlapping generations (OLG) model. In this OLG model when the stock of government debt is not paid off during the lifetime of any single generation, the assets and liabilities of the treasury do not cancel each other out as they would in the representative agent model. Their model shows that:
- Changes in real interest rates are redistributive across generations, and they may lead to fluctuations in the demand for government bonds that are self-stabilizing;
- As wealth effects can be very persistent, the model generates prolonged periods of negative real interest rates, similar to those we have observed in recent data;
- Unlike the FTPL, a benevolent monetary policy maker who pursues an interest rate peg cannot rely on fiscal policy to anchor the price level;
- Calibrating the model to an income profile from U.S. data shows that the FTPL breaks down.
A Requiem for the Fiscal Theory of the Price Level
Authors: Roger Farmer, Pawel Zabczyk
From: IMF
…not so fast! Discount rates matter
Think about 2008. There was a big recession. Deficits zoomed, through bailout, stabilizers, and deliberate stimulus. Yet inflation.. declined. So how does the government debt valuation equation work? Well, maybe today’s deficits are bad, but they came with news of better future surpluses. That’s hard to stomach. And it isn’t true in the data. Well, real interest rates declined and sharply. The discount rate for government debt declined, which raises the value of government debt, even if expected future surpluses are unchanged or declined. With a lower discount rate, government debt is more valuable. If the price level does not change, people want to buy less stuff and more government debt. That’s lower aggregate demand, which pushes the price level down. Does this story bear out, quantitatively, in the data? Yes.
“The first piece of news in Figure 1 is that there are primary surpluses. One’s impression of endless deficits comes from the deficit including interest payments on the debt.”
New Paper — the fiscal roots of inflation
The Fiscal Roots of Inflation
Author: John H. Cochrane
From: Stanford University
