price level fall, either through money demand, based on the quantitative theory of
money, where prices decrease on a one to one basis with the change of money stock,
either through equation (25).
The main feature of the government budget constraint, the fact that public debt can not
go beyond the value of present and future budget surpluses, should be met, either in
equilibrium or not. This characteristic of the government constraint does not seem to be
adopted by the proponents of the FTPL, who assume that the budget constraint must be
fulfilled only in equilibrium, a hypothesis that is hard to sustain. See for example the
comments forwarded by Woodford (1998a, p. 17-18)):
“Note that our argument does not involve any denial that the value of the public debt
must actually equal the present value of future government budget surpluses, in
equilibrium. What we deny is that condition (1.14) [the initial value of public debt is
equal to the present value of current and future budget surpluses plus seigniorage] is a
constraint upon government fiscal policy, that must be expected to hold regardless of
the evolution of goods prices and asset prices. Instead of a "government budget
constraint", the condition is properly viewed as an equilibrium condition, that follows
from the joint requirements of private sector optimisation and market clearing.”11
Still another point assumed by the FTPL is also open to criticism: the assumption that
the government allways intends to rollover a fraction of the outstanding stock of public
debt. However, if the successive budget surpluses allow to significantly reduce the stock
of public debt, the hypothesis that the price level is determined by the intertemporal
government budget constraint, equation (6), implies that the price level would approach
zero. Notice that some of the EU-15 countries (for instance Ireland, Denmark, Finland,
United Kingdom) countries and the US, had in the last years consecutive budget
surpluses, resulting in the reduction of the stock of public debt, without significant
changes in the inflation rate.
Additionally, a contribution for an increase of inflation might be the occurrence of
defaults on interest rate payments and reimbursements of public debt. These situations
may then reduce the present value of future budget surpluses and the price level would
11 Still on the budget constraint, it does not seem clear the idea forwarded by Cochrane (2000) that
sees the constraint not as a restriction but like a “government valuation equation.”
18