The Fiscal Theory of the Price Level (Slower Song)

If the fisc misbehaves badly enough, There'll be serious inflation no matter what the Fed does. To understand the fiscal theory of the price level, You need to first understand the concept of the PRIMARY SURPLUS. The government's primary surplus is taxes minus all spending EXCEPT for interest payments. Imagine an asset (as if it were a stock or bond) that paid out the primary surplus every year. The value of that asset is called "the present value of the primary surplus." If that is worth less than the national debt, then prices have to rise To bring the real value of the national debt down to the present value of the primary surplus. That is, if people are not confident the government will pay its debts without inflation, then inflation will balance the books. If the fisc responds normally to the Fed, by raising the primary surplus when rates go up, then the government is on track to pay its debts without inflation beyond the Fed's inflation target. If the fisc doesn't raise the primary surplus when rates go up, watch out. Inflation ahoy!