Using structural balance data to test the fiscal theory of the price level: Some international evidence

The fiscal theory of the price level has recently received important attention as an alternative theory of price determination. Empirical tests of the FTPL have been rare, and have undergone forceful criticism by Cochrane [Cochrane, J., 1998. A frictionless view of US inflation. NBER Macroeconomics Annual. MIT Press, pp. 323-384] based on "observational equivalence" arguments. This paper proposes two extensions to the empirics of the FTPL. First, we apply the methodology initiated by Canzoneri et al. [Canzoneri, M.B., Cumby, R.E., Diba, B.T., 2001. Is the price level determined by the needs of fiscal solvency? American Economic Review 91, 1221-1238] to European data. Second, we use structural balance data, in order to overcome Cochrane's critique. Our conclusion is that for neither country the data support a FTPL interpretation, (c) 2006 Elsevier Inc. All rights reserved.