Is The Fiscal Theory of the Price Level Learnable?

During the past several years, a striking body of literature has appeared in which it is argued that general price level determination is essentially a fiscal, rather than monetary, phenomenon. The most prominent papers have been those of Woodford (1994, 1995, 2001), Sims (1994, 1997), Leeper (1991), and Cochrane (1998, 2000), but there are several others of significance.1 If the theory expounded in these papers was valid in actuality, there would be major implications for the manner in which fiscal and monetary policies should be conducted, not only in individual economies but also within monetary unions.2 The purpose of the present paper is to describe this theory and provide one major reason why I believe that it is not relevant to actual economies, but instead is basically misleading. That position has been put forth in McCallum (2001a), but the present argument includes a new, different, and more satisfactory justification. In addition, the basic exposition is simplified here and several extensions are developed.