Ricardian Fiscal Regime and Fiscal Theory of the Price Level: The European Monetary System

Abstract

Ricardian fiscal regime policy, which rejects the notion of fiscal policy determining the price level advocates the idea that primary budget surplus should be identified with respect to the public debt. On the other hand, relevant literature (Leeper (1991), Sims (1993), Woodford (1994, 1995, 2001), Cochrane (2001)) during 90’s gave birth to an approach called Fiscal Theory of the Price Level which based itself on the case where fiscal policy is not suffering from shortage of discipline, central banks cannot force effective policies to reach price level stabilization and aggregate price level will be determined by the government’s present value budget constraint. The main purpose of this study is to analyze The European Monetary System countries for the validity of Ricardian or non-Ricardian fiscal regime policies for the period 1995-2012 using panel cointegration and panel ARDL method. For the studied time period, the results point out that Ricardian fiscal regime is applicable.