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



debt. If, however, higher budget surpluses are associated with higher public debt, then it
is possible that there is in place a non-Ricardian regime, that is, a regime of fiscal
dominance. Still another test for the validation of the FTPL is to assess if the budget
surplus does not react systematically to the level of public debt. Then, the price level
could be determined by the government budget constraint, and not by money demand
and money supply. In this case, the price level may change to adjust the real value of the
stock of public debt to the present value of the future primary budget surplus. If,
however, one observes that the government tries to increase the budget surpluses in
order to diminish the existing stock of public debt and comply with the budget
constraint.

With annual data for the US, for the period 1951-1995, Canzoneri, Cumby and Diba
(2000) mention that positive shocks in the primary budget surplus, decrease the real
value of the stock of public debt, and therefore they conclude for the existence of
Ricardian regime, with the Treasury assuming a passive strategy and the Central Bank
assuming an active strategy. Also, Canzoneri, Cumby and Diba (1997) mention that it
does not seem to be any empirical evidence concerning the existence of a regime of
fiscal dominance in the OECD countries.

Cochrane (1999) uses also a VAR model, with a single lag, with the following
variables: public debt as a percentage of private consumption, the budget surplus-private
consumption ratio, the consumption rate growth and the real interest rate implicit in the
stock of public debt. With annual data for the US, for the period 1960-1996, they
conclude that positive changes in the budget surplus reduce the stock of public debt, a
result similar to the one reported by Canzoneri, Cumby and Diba (2000). Woodford
(1999) reaches the same conclusions as Cochrane (1999), with the same data and
variables, with the exception that the real interest rate is discarded, on the basis that it
should be implicit in the evolution of the other three variables (see Woodford [1999]).14

Other empirical work, that relate to this discussion, is provided by Debrun and Wyplosz
(1999) and Mélitz (2000) who estimate reaction functions respectively for the UE-12
and OECD countries, in order to evaluate if the primary budget surplus responds

14 Indeed, Cochrane (1998) mentions that the estimations of the equations for the real interest rate
and for the rate growth of consumption are not statistically very robust.

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