The fiscal theory of the price level in an open economy

Recent work (Loyo, E., Going international with the fiscal theory of the pr ice level. Manuscript, John F. Kennedy School of Government, Harvard Univer sity, 1998; Dupor, B., Exchange rates and the fiscal theory of the price le vel. Journal of Monetary Economics 45, 613-630) has shown that extension of the fiscal theory of the price level to an open economy yields indetermina te prices and exchange rates, calling into question the usefulness of the t heory. This paper shows that by carefully tailoring policies in an independ ent fashion, governments can eliminate price and exchange rate indeterminac y. Specifically, governments are assumed to care about the welfare of their agents so that they never set policy to yield an intertemporal government budget surplus. (C) 2001 Elsevier Science B.V. All rights reserved.