OSIPP Discussion Paper : DP-2022-E-002

Review of the Fiscal Theory of the Price Level
April 25, 2022
Hidekazu Niwa*
Assistant Professor, Osaka School of International Public Policy (OSIPP)【JEL Classification】E58, E63, E31【Keywords】Fiscal Theory of the Price Level; Fiscal-Monetary Interaction;
Government Solvency【Abstract】This study reviews the fiscal theory of the price level (FTPL). Our
goal is to briefly explain the following three points. First, how is an equilibrium
determined in a simple model where prices are perfectly flexible and only oneperiod government bonds? Second, what is the intuition for equilibrium
determination? Third, how does introducing long-term bonds or nominal pricerigidities change results in the simplest case?

*

Email: niwa@osipp.osaka-u.ac.jp

This paper is a revised version of the second chapter of my Ph.D. dissertation at Hitotsubashi
University. I am deeply grateful to Etsuro Shioji for his special advice and encouragement. Anyremaining errors are the sole responsibility of the author.

11 Introduction
This study reviews the fiscal theory of the price level (FTPL). The foundation of thisliterature is developed by Leeper (1991), Sims (1994), Woodford (1995, 1996, 2001), andCochrane (2001). They stress the importance of a role that expectations about the future
conduct of fiscal policy play in determining the equilibrium price level. In standard models
for monetary policy analysis, it is implicitly assumed that the fiscal authority commits toadjusting the present discounted value (PDV) of primary surpluses to ensure solvency ofthe consolidated government. Therefore, the central bank achieves independent control of
inflation by setting the short-term nominal interest rate appropriately. However, if the fiscal
authority does not make such adjustments, the equilibrium price level must be determinedso as to maintain the sustainability of public debt.
The objective of this study is to briefly explain the following three points. First, how is
an equilibrium determined in a simple model in which prices are perfectly flexible and all
government bonds are one-period? Second, what is the intuition for the equilibrium
determination? Third, how does introducing long-term bonds or nominal price rigidities
change results in the simplest case? We provide a textbook-style explanation by using a toy
model. The discussion in this study is mainly based on Woodford (1995, 1996, 2001),
Cochrane (2001, 2005, 202), Iwamuma and Watanabe (2004), and Shioji (2018).

2 Two-period Model2

We work with a deterministic two-period model with sticky prices. The two periods
are 𝑡 = 0, 1. The economy is populated by a representative household, a continuum offirms in the unit interval, the fiscal authority, and the central bank. In period 0, firms faceadjustment costs in changing their prices so that prices are rigid. In period 1, they canchange their prices at no costs so that prices are perfectly flexible. The fiscal authority
issues government bonds, which are held by the households. At the beginning of period 0,
the household holds initial wealth one-period and long-term government bonds. The
important assumption in the FTPL is that the fiscal authority does not adjust primary
surpluses to maintain government solvency. The central bank controls the short-term
nominal interest rate. Finally, it should be noted that the model described below
encompasses the simplest case in which prices are perfectly flexible, and all government
bonds are one-period as a special case.

2.1 Households
The representative household has the following utility function
log(𝐶0 ) − 𝑁0 + 𝛽[log(𝐶1 ) − 𝑁1 ],(1)where 𝐶𝑡 is an aggregate of consumption, 𝑁𝑡 is labor supplied, and 𝛽 ∈ (0,1) is thediscount factor. The aggregate consumption 𝐶𝑡 is defined as
1

𝐶𝑡 ≡ [∫𝜃𝜃−1
𝜃−1𝑐𝑡 (𝑗) 𝜃 𝑑𝑗] ,(2)0where 𝑐𝑡 (𝑗) denotes the quantity of good 𝑗 ∈ [0,1] consumed by the households. 𝜃 > 1

3

parameterizes the elasticity of substitution across goods. The aggregate price index is
1
1−𝜃

1

𝑃𝑡 ≡ [∫ 𝑝𝑡 (𝑗)1−𝜃 𝑑𝑗]

,

(3)

0

where 𝑝𝑡 (𝑗) denotes the price of good 𝑗.
At the beginning of period 0, the household holds one-period, risk-free nominal bonds
𝐵−1 and long-term bonds 𝐷−1 . Long-term government bonds outstanding at the beginningof period 0 pay one dollar in period 0 and 𝜌 dollars in period 1. In a special case with 𝜌 = 0,
all government bonds outstanding in period 0 are one-period. The price of a one-period
government bond is denoted by 1⁄(1 + 𝑖𝑡 ), where 𝑖𝑡 is the short-term nominal interest rate,and 𝑄𝑡 denotes price of long-term bonds. The household earns labor income 𝑁𝑡 𝑊𝑡 , where
𝑊𝑡 is the nominal wage, receives profits 𝑍𝑡 (𝑗) from firm 𝑗, and pays lump-sum taxes 𝑇𝑡 .
Since all government bonds newly issued in period 0 are one-period, the budget constraint
is given by

𝑃0 𝐶0 +

1
𝐵0
≤ 𝐵−1 + (1 + 𝑄0 )𝐷−1 + 𝑊0 𝑁0 + ∫ 𝑍0 (𝑗)𝑑𝑗 − 𝑃0 𝑇0 ,1 + 𝑖0
0(4)

The budget constraint in period 1 can be written as
1
𝐵1
𝑃1 𝐶1 +
≤ 𝐵0 + (𝜌 + 𝑄1 )𝐷−1 + 𝑊1 𝑁1 + ∫ 𝑍1 (𝑗)𝑑𝑗 − 𝑃1 𝑇1.
1 + 𝑖1
0(5)The household is also subject to a constraint that prevents it from dying with debt at theend of period 1:

4

𝐵1
≥ 0.
1 + 𝑖1(6)

2.2 Firms
There is a continuum of monopolistically competitive firms indexed by 𝑗 ∈ [0,1]. Firm 𝑗
produces goods using the production technology(7)𝑦𝑡 (𝑗) = 𝑛𝑡 (𝑗) .
where 𝑛𝑡 (𝑗) is the labor hired. Firm 𝑗 faces a downward-sloping demand curve given by−𝜃𝑝𝑡 (𝑗)
𝑦𝑡 (𝑗) = (
)
𝑃𝑡

(8)

𝑌𝑡 .

𝜃

where

𝜃−1
𝜃−1
1
𝑌𝑡 ≡ [∫0 𝑦𝑡 (𝑗) 𝜃 𝑑𝑗]

denotes aggregate output. In period 0, firms faceadjustment costs in changing their prices. Following Rotemberg (1982), firm 𝑗 faces priceadjustment costs:2

𝛾 𝑝0 (𝑗)(− 1) 𝑌0 .
2 𝑝−1 (𝑗)(9)𝛾 is the parameter that controls the degree of nominal price rigidities. When 𝛾 = 0, firms
can change their prices at no costs so that prices are perfectly flexible in both periods.
The profits of firm 𝑗 in period 0 is then expressed as2

𝛾 𝑝0 (𝑗)𝑍0 (𝑗) = [𝑝0 (𝑗)𝑦0 (𝑗) − 𝑊0 𝑦0 (𝑗) − 𝑃0 (− 1) 𝑌0 ] .
2 𝑝−1 (𝑗)(10)

As in period 1, there are no price adjustment costs; profits in this period can be rewritten as5

𝑍1 (𝑗) = [𝑝1 (𝑗)𝑦1(𝑗) − 𝑊1 𝑦1(𝑗) ].

(11)

2.3 Government
The fiscal authority imposes lump-sum taxes on the households and issues bonds, oneperiod bonds 𝐵𝑡𝐹 and long-term bonds 𝐷𝑡𝐹 , respectively. The flow government budget
constraints in each period are given by𝐹𝐹(1 + 𝑄0 )𝐷−1
+ 𝐵−1
=

𝐵0𝐹
+ 𝑃0 𝑇0 ,1 + 𝑖0(12)𝐹(𝜌 + 𝑄1 )𝐷−1
+ 𝐵0𝐹 =𝐵1𝐹
+ 𝑃1 𝑇1 .
1 + 𝑖1

(13)

1
𝑏0𝐹
𝐹
𝐹 ]
[(1 + 𝑄0 )𝐷−1
+ 𝐵−1
=
+ 𝑇0,
𝑃0
1 + 𝑖0

(14)

1
𝑏1𝐹
𝐹
𝐹
[(𝜌 + 𝑄1 )𝐷−1 + 𝐵0 ] =+ 𝑇1,
𝑃1
1 + 𝑖1(15)

They can be rewritten in real terms:

where 𝑏𝑡𝐹 ≡ 𝐵𝑡𝐹 ⁄𝑃𝑡 is the real value of one-period government bonds.
The central bank controls the short-term nominal interest rate 𝑖𝑡 .

2.4 Equilibrium conditions
This subsection describes the equations that characterize an equilibrium allocation. The
household maximizes its lifetime utility (1) subject to the budget constraints (4) and (5) andthe no-Ponzi game condition (6). The Euler equation in period 0 is given by

6

1
𝐶0
= 𝛽 Π1−1 ,1 + 𝑖0𝐶1(16)

where Π𝑡 ≡ 𝑃𝑡 ⁄𝑃𝑡−1 is the gross inflation. The optimality condition for labor supply is
𝑊𝑡= 𝐶𝑡 for 𝑡 = 0,1.
𝑃𝑡

(17)

Given the no-arbitrage condition between one-period and long-term bonds, the price oflong-term bonds must satisfy
𝑄0 =1(𝜌 + 𝑄1 ),1 + 𝑖0(18)

𝑄1 = 0(19)

Finally, since the household has no incentive to save in period 1, the household
optimization requires that the following terminal condition holds:
𝐵1=0
1 + 𝑖1(20)

Next, firms’ profits maximization is considered. Firm 𝑗 sets its price in each period{𝑝0 (𝑗), 𝑝1 (𝑗)} to maximize profits (10) and (11) subject to the downward-sloping demand
curve (8). Deriving the first-order conditions in each period and focusing on a symmetricequilibrium where 𝑝𝑡 (𝑗) = 𝑃𝑡 , the following conditions are obtained:(1 − 𝜃 ) + 𝜃𝐶0 = 𝛾Π0 (Π0 − 1),(21)

𝐶1 = 1 − 𝜃 −1 .

(22)

7

Equation (21) shows that when 𝛾 = 0, 𝐶0 is also fixed at 1 − 𝜃 −1 . The Phillips curve inperiod 1 is vertical as prices are perfectly flexible.
Clearing in the goods market requires that𝛾[1 − (Π0 − 1)2 ] 𝑌0 = 𝐶02

(23)

𝑌1 = 𝐶1 .

(24)

Equilibrium in the bonds market requires that
𝐵𝑡𝐹 = 𝐵𝑡

for

0, 1

𝐹
𝐷−1
= 𝐷−1 .

(25)
(26)

To complete the characterization of the equilibrium, we need to specify rules according
to which fiscal and monetary policies are chosen. We assume that the fiscal authority precommits to a certain sequence of primary surpluses as follows:
𝑇𝑡 = 𝑇̅𝑡 for 0, 1.

(27)This means that the fiscal authority does not make fiscal adjustments needed to maintain
government solvency, unlike standard models. As explained, this assumption plays acritical role in the FTPL. The central bank also exogenously sets the short-term nominalinterest rate in period 0:
𝑖0 = 𝑖̅0 .

(28)

Since the fiscal authority does not adjust primary surpluses, government solvency
condition is relevant; endogenous variables must be determined so as to ensure government8

solvency. Combining flow government budget constraints in each period, (14) and (15), andimposing the terminal condition (20), the government solvency condition in period 0 is
obtained:1Π[(1 + 𝑄0 )𝐷−1 + 𝐵−1 ] = 𝑇̅0 + ( 1 ) 𝑇̅1
𝑃0
1 + 𝑖0(29)
𝐶0= 𝑇̅0 + 𝛽 ( ) 𝑇̅1
𝐶1
When deriving equation (29), we have used the bonds market clearing condition (25) and(26) and the Euler equation (16) that describes the relationship between the real interest rate
and the path of consumption. Imposing the terminal condition (20) on government budget
constraint (15) gives the government solvency condition in period 1:
1[(𝜌 + 𝑄1 )𝐷−1 + 𝐵0 ] = 𝑇̅1 .
𝑃1

(30)

Equilibrium in this model is a collection of process {𝑌𝑡 , 𝐶𝑡 , Π𝑡 , 𝑄𝑡 }1𝑡=0 that satisfy (18),(19), (21)–(24), (29), and (30) given the predetermined variables {𝐵−1 , 𝐷−1 , 𝑃−1 } and policy
variables {𝑇̅0 , 𝑇̅1 , 𝑖̅0 } . We need to choose a value for 𝑃−1 to uniquely determine theequilibrium path of the inflation rate.

3 The Simplest Case in Which 𝛄 = 𝝆 = 𝟎
Using the above model, we study how the equilibrium is determined. First of all, thesimplest case in which 𝛾 = 𝜌 = 0 is considered: we assume that prices are perfectly
flexible and all government bonds are one-period. This is a simplified version of models

9considered by Leeper (1991), Sims (1994), and Woodford (2001). They study flexible-pricemodels of endowment economy. 2

3.1 Equilibrium determination
In a case with 𝛾 = 0, the goods market clearing condition in period 0 (23) can be
rewritten as
𝑌0 = 𝐶0(31)

Since 𝛾 = 0 implies that 𝐶0 = 1 − 𝜃 −1, the government solvency condition in period 0 (30)can be expressed as
1(𝐷 + 𝐵−1 ) = 𝑇̅0 + 𝛽𝑇̅1 .
𝑃0 −1

(32)

This is the key condition to uniquely determining the equilibrium price level. Since in thecase of flexible-prices, the real interest rate is fixed at 𝛽−1 − 1, the PDV of primary
surpluses 𝑇̅0 + 𝛽𝑇̅1 is unchanged. The nominal value of outstanding government bonds
𝐵−1 + 𝐷−1 is predetermined in period 0. We can thus uniquely determine the current pricelevel 𝑃0 to satisfy the government solvency condition (32). In other words, 𝑃0 is determinedto equate the real value of outstanding government bonds and the PDV of primary surpluses.
The important point here is that as the fiscal authority does not adjust primary surpluses,
the endogenous variables (the current price level in this simplest case) should adjust so as
to maintain government solvency in the equilibrium.

2

To be precise, they consider infinite-horizon models in which money is demanded.

10

3.2 Intuition Ⅰ: Government bonds as net wealth
What is the intuition for the equilibrium determination? To examine this, we focus on the
optimizing decision of the household. Combining the flow budget constraints in eachperiod (4) and (5) gives the household’s intertemporal budget constraint
𝐶0
𝐶0 + 𝛽 ( ) 𝐶1 ≤ 𝐵−1 + 𝐷−1
𝐶1
1

1
𝐶0
𝐶0
+𝑊0 𝑁0 + ∫ 𝑍0 (𝑗)𝑑𝑗 + 𝛽 ( ) (𝑊1 𝑁1 + ∫ 𝑍1 (𝑗)𝑑𝑗) − [𝑇̅0 + 𝛽 ( ) 𝑇̅1 ].
𝐶1
𝐶1
0
0

(33)

Moreover, imposing the optimality conditions of the households (17) and (20), theoptimality conditions of firms (21) and (22), and goods market clearing conditions (24) and(31), we obtain the following condition:
1(𝐷 + 𝐵−1 ) + (1 + 𝛽)(𝜃 − 1) − (𝑇̅0 + 𝛽𝑇̅1 ) = 𝐶0 + 𝛽𝐶1.
𝑃0 −1

(34)

Note that equation (34) is one of the equilibrium conditions as it contains information about
the optimality conditions of the private sector.
The condition (34) is informative about how an increase in outstanding government
bonds 𝐷−1 + 𝐵−1 affects the optimizing decision of the household. Recall that since thefiscal authority is assumed not to adjust primary surpluses regardless of the amount ofbonds outstanding, the PDV of primary surpluses 𝑇̅0 + 𝛽𝑇̅1 is unchanged. An increase in
outstanding bonds then leads to an increase in the PDV of lifetime income of the household,which is given by the left-hand side of the condition (34), and then stimulates thehousehold’s demand for goods. In other words, an increase in outstanding bonds induces a11positive wealth effect on the household. This expands aggregate demand and thereby
requiring a rise in the price level 𝑃0 . Since the aggregate supply of goods is fixed, theequilibrium condition (34) is restored solely by a change in the price level 𝑃0 .
The above discussion confirms that when the fiscal authority does not adjust primary
surpluses, the Ricardian equivalence does not hold. Indeed, in the FTPL, an increase in
outstanding bonds induces a change in the optimizing decision of the household andtherefore affects the equilibrium price level.

3.3 Intuition Ⅱ: Stock analogy discussed by Cochrane (2005)
In this section, we introduce another explanation for the economic mechanism behind theadjustment in the price level in the FTPL, which is highlighted in Section 3.1. Cochrane(2005) draws an analogy between the FTPL in which the equilibrium price level isendogenously determined to maintain government solvency—and the theory of stock pricedetermination.3 More specifically, he argues that government bonds, including monetarybase, share a similar property with stocks, which is the security that private corporations
issue with a promise of future dividends. As well-known, the stock price is determined toequate its market value (stock price × number of stocks) and the PDV of future dividends.
This implies that stock prices reflect how market participants evaluate the ability of thecorporation to make profits in the future. For example, a decrease in the PDV of future
dividends leads to a decline in stock price.

3

His idea is also introduced by Iwamura and Watanabe (2004), Shioji (2018), and Cochrane (2019).

12

One of the main messages of Cochrane (2005) is that the same logic determines theprice of government bonds (the inverse of the price level) in the FTPL. He writes that “Thefiscal theory of the price level recognizes that nominal debt, including the monetary base, isa residual claim to government primary surpluses, just as Microsoft stock is a residual
claim to Microsoft’s earnings” (p.502). As explained in the previous section, in the FTPL,
the price of government bonds is endogenously determined so as to equate the real value ofgovernment bonds and the PDV of primary surpluses. In this sense, the price ofgovernment bonds reflects how the public evaluates the government’s ability (orwillingness) to raise primary surpluses in order to return goods to bond holders in the future.
Indeed, the government solvency condition in period 0 (32) shows that when the PDV ofprimary surpluses decreases, the real value of government bonds declines (the price level
increases). In other words, in the FTPL, the real value of government bonds is
endogenously determined by public confidence in the government.

4 Case with Long-Term Bonds
Next, the case in which 𝛾 = 0 and 𝜌 > 0 is considered; we assume that long-term bonds areoutstanding at the beginning of period 0. Cochrane (2001) and Woodford (2001) study the
FTPL with long-term bonds. For simplicity, prices are assumed to be perfectly flexible, as
in the previous case.

4.1 Equilibrium determination
When 𝜌 > 0, the government solvency condition can be written as
13

1
1
𝜌
[(1 + 𝑄0 )𝐷−1 + 𝐵−1 ] = [(1 +) 𝐷 + 𝐵−1 ]𝑃0
𝑃0
1 + 𝑖̅0 −1(35)= 𝑇̅0 + 𝛽𝑇̅1
As prices are perfectly flexible, the real interest rate is fixed, and so is the PDV of primary
surpluses. The important point in the case with long-term bonds is that the nominal value ofoutstanding government bonds (1 + 𝑄0 )𝐷−1 + 𝐵−1 is no longer predetermined in period 0.
The reason is that the price of long-term bonds 𝑄0 depends on the current short-term
nominal interest rate 𝑖̅0 . Then, the current price level 𝑃0 is uniquely determined to satisfy
the government solvency condition (35), given the policy variables {𝑇̅0 , 𝑇̅1, 𝑖̅0 } and thepredetermined variables {𝐵−1 , 𝐷−1 } . It is worth noting that when long-term bonds areoutstanding, not only fiscal policy but also monetary policy plays a role in determining theprice level since it affects the price of long-term bonds.

4.2 Numerical illustration
This section presents a numerical example to show how a change in the price of long-termbonds affects the dynamics of the equilibrium price level. We adopt 𝛽 = 0.5 and 𝜃 =10.
Outstanding bonds in period 0 are given by 𝐵−1 = 1 and 𝐷−1 = 1. The price level in the
period – 1 is set to 𝑃−1 = 1. Primary surpluses in periods 0 and 1 are set to 𝑇̅0 = 𝑇̅1 = 1.
Figure 1 displays a numerical example of the price level in periods 0 and 1. We report
the results for alternative values of 𝑖̅0. When the nominal interest rate is increased, the price14

Figure 1. A numerical example of the price level in periods 0 and 1 at alternative values of 𝑖̅0 .

of long-term bonds declines. This leads to a decrease in the price level in period 0 and anincrease in the price level in period 1. This result suggests that when long-term bonds areoutstanding, the government can choose the timing of inflation needed to maintain its
solvency by changing the price of bonds. For example, lowering the price of long-termbonds, which corresponds to a higher price level in the next period, reduces the reliance on
current inflation.
An economic mechanism through which a decline in the price of bonds leads to a lower
price level is clear in light of the fact that, in the FTPL, government bonds are net wealthfor the households. When the fiscal authority does not adjust primary surpluses, a decline in
the price of long-term bonds held by households induces negative wealth effects. This
reduces aggregate demand and therefore lowers the price level.

155 Case with Nominal Rigidities
Finally, the case in which 𝛾 > 0 and 𝜌 = 0 is considered; we assume that prices are rigid inperiod 0. We analyze this case following Woodford (1996), the first study that incorporate
the FTPL framework into a New Keynesian framework. When prices are rigid, afluctuation of aggregate demand is not absorbed entirely by a change in the price level. This
also requires a variation in the level of real economic activities and then in the real interest
rate. For simplicity, it is assumed that all government bonds are one period.

5.1 Equilibrium determination
When 𝛾 > 0 and 𝜌 = 0, the government solvency condition in period 0 is given by1Π[𝐷−1 + 𝐵−1 ] = 𝑇̅0 + ( 1 ) 𝑇̅1
𝑃0
1 + 𝑖0(36)= 𝑇̅0 + 𝛽 (

𝐶0
) 𝑇̅
𝐶1 1

In a case with 𝜌 =0, the nominal value of outstanding bonds 𝐷−1 + 𝐵−1 is predetermined inperiod 0. The important point is that, in contrast to the previous two cases, due to nominal
rigidities, the government solvency condition cannot be satisfied solely by a change in theprice level 𝑃0 . A change in the real interest rate is also needed. Given that the level ofconsumption in period 1 𝐶1 is fixed, not only the price level 𝑃0 but also consumption 𝐶0
should adjust to satisfy the government solvency condition (36).

16Therefore in the case with nominal rigidities, the equilibrium price level is not uniquelydetermined solely by the government solvency condition, unlike in the two previous cases.
We need another equilibrium condition to be combined with the government solvency
condition to determine the price level and consumption. The Phillips curve (21) describes
the relationship between inflation and consumption in period 0. The price level 𝑃0 andconsumption 𝐶0 are jointly determined to satisfy both the Phillips curve (21) and thegovernment solvency condition (36), given the policy variables {𝑇̅0 , 𝑇̅1 , 𝑖̅0 } and thepredetermined variables {𝐵−1 , 𝐷−1 , 𝑃−1 }.

5.2 Numerical illustration
This section presents a numerical example to show how a change in the degree of nominal
rigidities affects inflation and real interest rate in period 0. We use the same values for 𝛽, 𝜃,
𝐵−1 , 𝐷−1 , 𝑇̅0, 𝑇̅1, and 𝑃−1 as in Section 4.2, and adopt 𝜌 = 0.1.
Figure 2 displays the price level, the real interest rate, the net inflation rate, andconsumption in period 0. We report results for ten values of 𝛾 , 𝛾 ∈ {0, 10, 20, 30, 40 ,50, 60, 70, 80, 90 ,100}. The numerical result shows that when prices are stickier (i.e., as 𝛾
becomes larger), a larger decline in the real interest rate is needed to maintain government
solvency. Given more sluggish adjustments in the price level, the government must put
more reliance on a decline in the real interest rate to maintain its solvency.
It is also worth noting that consumption increases as prices are stickier. As explained in
the FTPL, the outstanding government bonds put upward pressure on aggregate demand17Figure 2. A numerical example of the price level, the real interest rate, the net inflation rate, and consumption
in period 0 at alternative values of 𝛾.

through the positive wealth effect. Given more sluggish adjustments in prices, an increasein consumption is needed to ensure goods market clearing.

18

6 Concluding Remarks
This study briefly reviewed the FTPL using a simple model. We have studied how theequilibrium is determined in three cases: (ⅰ), the simplest case in which prices are perfectly
flexible, and all government bonds are one-period, (ⅱ), the case with long-term bonds, and(ⅲ), the case with nominal rigidities. The important point common to the three cases is thatin the FTPL the Ricardian equivalence does not hold so that an increase in outstanding
bonds induces a positive wealth effect on households and therefore affects the equilibrium
allocations. Again, the assumption that the fiscal authority does not make fiscal adjustments
needed to maintain government solvency plays a critical role.

References
Barro, R. J. (1974). “Are Government Bonds Net Wealth?.” Journal of Political
Economy, 82(6), 1095-1117.
Cochrane, J. H. (2001). “Long‐Term Debt and Optimal Policy in the Fiscal Theory of thePrice Level.” Econometrica, 69(1), 69-116.
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