The Fiscal Theory of the Price Level in a World of Low Interest Rates

40 Pages Posted: 5 Feb 2018 Last revised: 12 Aug 2022

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2018

Abstract

This working paper was written by Marco Bassetto (Federal Reserve Bank of Chicago, University College London, and IFS) and Wei Cui (University College London and Centre for Macroeconomics).

A central equation for the fiscal theory of the price level (FTPL) is the government budget constraint (or “government valuation equation”), which equates the real value of government debt to the present value of fiscal surpluses. In the past decade, the governments of most developed economies have paid very low interest rates, and there are many other periods in the past in which this has been the case. In this paper, we revisit the implications of the FTPL in a world where the rate of return on government debt may be below the growth rate of the economy, considering different sources for the low returns: dynamic inefficiency, the liquidity premium of government debt, or its favorable risk profile.

Keywords: the fiscal theory of price level, risks, dynamic inefficiency, and liquidity

JEL Classification: E31, E62

Suggested Citation

Institute for Monetary and Financial Research, Hong Kong, The Fiscal Theory of the Price Level in a World of Low Interest Rates (January 1, 2018). Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 02/2018, Journal of Economic Dynamics and Control, Vol. 89, No. Pages 5-22, 2018, Available at SSRN: https://ssrn.com/abstract=3110356

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