DP7630 | Can the Fiscal Theory of the price level explain UK inflation in the 1970s?

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We investigate whether the Fiscal Theory of the Price Level can deliver a reasonable explanation for UK inflation in the 1970s, a period in which the government greatly increased public spending without raising taxes and monetary policy was accommodative. The model is tested for its implied cointegration between inflation and government spending and for its dynamics by using the method of indirect inference, under which the model?s simulated behaviour is compared with the inflation time-series process. We find that the model is accepted in both respects.