Original sin, sovereign default, and the limits of the fiscal theory of the price level

The Fiscal Theory of the Price Level (FTPL) argues that inflation adjusts to ensure that the real value of government liabilities equals the expected present value of future primary surpluses. This mechanism is plausible in economies whose public debt is predominantly denominated in domestic nominal currency. Its applicability to emerging markets is less obvious. This paper argues that the standard FTPL has limited explanatory power in economies affected by "original sin"-the inability to borrow long term in their own currency. In such economies, a large share of public debt is denominated in foreign currency, indexed, or issued at very short maturities, reducing the ability of inflation to restore fiscal solvency. The government's intertemporal budget constraint remains fully applicable, but the adjustment mechanism changes. Fiscal crises are more likely to culminate in default, debt restructuring, financial repression, capital levies, or changes in the exchange rate regime than in successful inflationary liquidation of public debt. Original sin does not invalidate fiscal dominance; it alters the channels through which intertemporal fiscal equilibrium is restored.