The fiscal theory of the price level and sluggish inflation: how important shall the wealth effect be?

Jérôme Creel (1) , Henri Sterdyniak (1)

1 OFCE - Observatoire français des conjonctures économiques (Sciences Po)

According to the fiscal theory of the price level (FTPL), the interactions between monetary and fiscal policies with governments facing the possibility to act in a non-Ricardian manner make the general price level be fully determined. Here, depending on the expectations framework, we show to what extent the validity of the FTPL also depends on consumers being non-Ricardian. With prices driven by rational expectations, the qualitative results of the strategic interactions between policies do not depend on the Ricardian or non-Ricardian behaviour by the households. With sluggish inflation, the strong version of the FTPL does not bring to a dynamically stable economy. The economy is stable only for a weak version of the FTPL; but, this time, stability conditions depend strongly on the existence and size of the wealth effect. If inflation is sluggish, the FTPL is incompatible with Ricardian consumers.

Domains: Economics and Finance

Jérôme Creel, Henri Sterdyniak. The fiscal theory of the price level and sluggish inflation: how important shall the wealth effect be?. 2002. ⟨hal-00972779⟩