This sort of interpretations is rejected by Cochrane (1999) who tries to reconcile these
data with the FTPL, arguing that real primary deficits determined inflation, since after
the middle of the 80s there were improved expectations concerning future budget
surpluses. Hence, when there are changes in the expectations about the level of future
budget balances, the present value of fiscal balances is also adjusted, and this must be
reflected on the change of the government liabilities, through price level changes.
Therefore, with this reasoning, it is interesting to mention that in the 90s, at the same
time that the US budget deficit declined, becoming even a surplus after 1998, it was
possible to see a sustained decrease of the inflation rate.
Also, it is also relevant to distinguish between the money measure included in the
equation of the quantitative theory of money and the monetary liability used in the
government budget constraint. Indeed, in the equation of the quantitative theory of
money, for instance equation (1), money is seen as a broader monetary aggregate (M1,
M2 or even M3) than the monetary base used to to quantify the seigniorage revenues in
the government budget constraint, equation (6).
Assume, for example, that the monetary authority reduces the money supply. If there is
a Ricardian regime, of monetary dominance, the decrease of money supply should result
in a drop of the price level. Notice also that this price level decline will bring about an
increase of the real value of the outstanding stock of public debt, and, in the future, the
government will have either to raise taxes or to cut public expenditures, in order to meet
the budget constraint.
If there is a non-Ricardian regime, of fiscal dominance, a decrease in the money supply
dose not affect the price level since this variable is now determined through equation
(25). However, the equilibrium price level should now be smaller than the one that was
in place previously to the money supply cut, in other words, there might be too much
inflation. This situation would be possible if the government did not obey, for some
time, its budget constraint. The budget constraint would then only be fulfilled for a
long-run equilibrium situation, which seems to be a rather strong assumption. As a
matter of fact, the government budget constraint is, by construction, an identity that
should hold at any point in time. Eventually, if for instance the reduction of money
supply was associated to a tax raise, then the money supply decrease would end up in a
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