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The fiscal theory of the price level

This is the title of a 584-page book by John Cochrane that will be published in a few short months. The subtitle reads: “A comprehensive account of how government deficits and debt drive inflation.” And with that many pages, it clearly has a lot to say and the timing couldn’t be better. A recent article in The Wall Street Journal by Greg Ip explains why we may start to hear more about this economic theory as rising inflation and debt remain real concerns for citizens and government officials alike. 

So let’s talk about what the fiscal theory of the price level (FTPL) is, why business reporters should understand it, and where you can learn more about it

What is FTPL?

The general premise of FTPL is that fiscal and monetary policy not only interact, they are inextricably linked. It is thought that traditional macroeconomic models are not able to predict the path inflation will take. But FTPL theorists believe that this theory could indicate where it will go by looking at the way the government chooses to finance its debt on top of other fiscal policies. 

To paraphrase Greg Ip’s explanation of FTPL, if the government is so irresponsible with managing its debt that the central bank has to print money and raise interest rates to control future inflation, the public will act in ways that drive inflation now, not later. The more governments rack up deficits, the less the public believes in the government’s ability to manage the economy. Therefore it is less about the money supply and more about public perception of the government’s debt repayment ability that impacts inflation.

All of this sounds good in theory, but critics argue that the theory doesn’t stand up to real-life situations. For example, the 2008 recession saw government debt increase but inflation decrease. Cochrane has an explanation for why we are seeing inflation now, but not then. It boils down to the way the current government increased spending rather than just how much it spent. If the public understands that the spending will be paid back with taxes or spending cuts then they essentially trust the government to do what the government does.

Why should we care about FTPL now?

As Cochrane explains in his book summary, this theory is a good fit for what we are seeing in our economy today. Classical economic theories simply aren’t applicable in the same way that they used to be. Central banks don’t hold the same level of control as they once did and our theories need to adapt alongside the changing dynamics of our modern economy.

FTPL is certainly not perfect, no theory is. However, having an understanding of FTPL may help you look at business topics in a new way, especially in relation to how they impact the economy. The key takeaway from this theory is that fiscal and monetary policies impact one another and work in conjunction to affect the economy.

Thinking about a subject from a fresh perspective can only help you be a stronger writer and reach new readers. So why not take this opportunity to learn something new?

Learn more about FTPL

If you are interested in learning more about FTPL, here are a couple places to get you started.

Author

  • Julianne Culey

    Julianne is the Assistant Director of the Reynolds Center with expertise in marketing and communications and holds a master's in Sociology from Arizona State University.

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