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



5. Conclusion

The FTPL, credited mainly to the work of LSW, confers the government budget
constraint a key role in determining the price level. This is a relatively recent subject in
macroeconomics, nevertheless with increasing discussions in the literature. The more
active supporters of the theory (namely Woodford, Sims and Cochrane) argue that in a
non-Ricardian fiscal regime, the price level is determined by the ratio between nominal
public debt (or the government liabilities) and the present value of future primary fiscal
surpluses (including possible seigniorage revenues). The criticisms of the FTPL appear
to be more intense when the Central Bank decides to adopt an active strategy in
determining the nominal interest rate.

As many new topics and theories in economics, this is a rather controversial issue since
it directly questions the ability of monetary policy and of the quantitative theory of
money to explain and determine the price level. There are therefore already several
papers opposing this discussion of the monetary ortodoxy, being worthwile to mention
again McCallum and Buiter among the more hard-hearted critics.

Probably the main contribution of the FTPL, in its criticism of the quantitative theory of
money, is to discuss if the the price level may be determined, in part, and under some
given conditions, by fiscal policy. However, to distinguish between if the supply of
money and the interest rate are determined by fiscal policy or if the money supply and
interest rate are determined exogenously, it is not an easy point to assess either
theoretically or empirically. All in all, the theoretical assumptions required for the
existence of non-Ricardian regimes, where fiscal policy is actively determining the price
level, regardless of monetary policy, seem rather tricky to agree with.

Concerning the empirical assessment of the FTPL, the very few papers that atempted
that validation (for the US and for some OECD countries), with VAR models, conclude
for the existance of regimes of monetary dominance. This paper adds to the literature by
tentatively trying to test with panel data models, the feasibility of the FTPL for the EU-
15 countries. The results for the period 1970-2001 show, however, that the data allow
the rejection of the testable hypothesis used to validate the FTPL, since for instance, the
EU-15 governments have a tendency to use primary budget surplus to reduce the debt-

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