Fiscal Theory of the Price Level

The fiscal theory of the price level (FTPL) describes fiscal and monetary policy rules such that the price level is determined by government debt and fiscal policy alone, with monetary policy playing at best an indirect role. This theory clashes with the monetarist view that states that money supply is the primary determinant of the price level and inflation. Furthermore, many authors have argued that the fiscal rules upon which the FTPL relies are misspecified. We review the sources of disagreement, and highlight aspects upon which some consensus has emerged. The fiscal theory of the price level (FTPL) describes policy rules such that the price level is determined by government debt and the present and future tax and spending plans, with no direct reference to monetary policy. In understanding the FTPL and tracing its roots, we start from two simple relations: the velocity equation and the government budget constraint. The velocity equation defines the velocity of money in period t (Vt) as the ratio of nominal output (the price level Pt times real output Yt) to nominal money balances (Mt): Vt = PtYt Mt , t = 0, 1, . . . (1) ∗The New Palgrave Dictionary of Economics, forthcoming, Palgrave Macmillan, reproduced with permission of Palgrave Macmillan. This article is taken from the author’s original manuscript and has not been reviewed or edited.