Disturbing the fiscal theory of the price level: Can it fit the eu-15?

B_t ( 1 + r Y _{x                             zz},,₄

— = I —l(^tx - g).                      (25)

P_t   к r )

Therefore, according to the FTPL, P0 is determined by the previous expressions and is
given by

Po = ^rB0 /[(^{1 + r})(^{tx -} g)]^,                           (²⁶)

in other words, the price level is endogenously determined from the ratio between the
initial public debt level and the government balance. It is therefore somehow
understandable why Sims (1997, p. 8) labels this approach as “"quantity theory of
[public] debt" determination of the price level.”

3. A critical discussion of the fiscal theory

In a Ricardian regime, of monetary dominance, the nominal value of government debt
(or in a broader sense the government liabilities) results from the accumulation of
budget deficits. If the price level is determined by the quantitative theory of money, the
real value for the stock of public debt comes out endgenously and the present value of
future budget surpluses must adjust in order to meet the government budget constraint.

In the case of a non-Ricardian regime, of fiscal dominance, the real value of the stock of
public debt is determined by the present value of future budget surpluses, and the price
level that must adjust to gurantee the fulfilment of the budget government constraint.
What we have here is then two different interpretations on how the adjustment of the
several variables takes place in the framework of the government budget constraint. For
instance, Cochrane (2001) maintains that Ricardian regimes are backward-looking, in
the sense that the real values of the stock of public debt is determined by the price level
and by past budget deficits, while a non-Ricardian regime is forward-looking, since it is
now the real value of the stock of public debt, set accordingly with the present value of
future budget surpluses, that will determine the price level.

Price level indetermination is directly related to the fact that the Central Bank may use
monetary policy to determine the nominal interest rate. In this case, with the nominal

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