Monetary Policy and Exchange Rate Behavior in the Fiscal Theory of the Price Level

The fiscal theory of the price level has challenged the conventional view that monetary factors drive prices and exchange rates and has also provided a rationale for fiscal restrictions in a monetary union. This paper reviews the main results and compelling criticisms of this theory, analyzing the effects of monetary and fiscal shocks under a fiscal regime. We pay special attention to the determinants of the exchange rate and to the ways to eliminate the exchange rate indeterminacy that arise under interest rate peg.