Fiscal Requirements for Price Stability When Households are Not Ricardian

Are restrictions on fiscal policy necessary for monetary policy to be able to deliver price stability? When households are Ricardian, the Fiscal Theory of the Price Level asserts that the government's intertemporal budget constraint must hold for on-target inflation. We show that when households are not Ricardian, fiscal requirements still exist but are very different. (1) Intertemporal budget constraints no longer impose any significant requirement on fiscal policy for price stability. A requirement derived from intertemporal budget constraints still exists, but it does not correspond to the one of the government and imposes much looser requirements on fiscal policy than in the Ricardian case. (2) Yet a second requirement exists, specific to non-Ricardian households: Public debt must remain below a threshold. Above it, its wealth effect on aggregate spending can no longer be counter-balanced by interest rate hikes, however large. This second requirement puts an upper bound on public debt regardless of future fiscal surpluses. Assessing risks of fiscal dominance is therefore very different when households are not Ricardian.