Staff Working Paper No. 1,137
By Thomas W L Norman and Tim Willems
The fiscal theory of the price level (FTPL) posits that the price level ensures the Government’s budget equation is met in equilibrium, but is silent on the exact mechanism. By modeling the Government as a large, satiable player in a game with households, we demonstrate that the FTPL’s outcome can be understood as a ‘dividend equilibrium’, achieved via price level-driven revaluation of initial debt. It coincides with the Core (ensuring stability) and the unique outcome consistent with players receiving their Shapley Value. The price level envisioned by the FTPL thus emerges endogenously. In the open economy, however, a sufficiently indebted country loses the power to implement its ideal fiscal policy.
A game-theoretic foundation for the fiscal theory of the price level
