Filippo Gaddo, Managing Director at Alvarez & Marsal, SPE Councillor and host of the Econ Thoughts SPE Podcast, spoke with Eric Leeper, Paul Goodloe McIntire Professor of Economics at the University of Virginia, about the fiscal theory of the price level, fiscal dominance and the future of monetary policy in a high-debt world.

In the conversation, Eric explains the core intuition behind the fiscal theory of the price level: inflation is not solely a monetary phenomenon but also reflects how government debt is backed (or not) by future primary surpluses. Drawing on his long-standing research, including his seminal work on active and passive policy regimes, he argues that when fiscal authorities run persistent deficits without credible plans to stabilise debt, monetary policy alone cannot anchor the price level. The post-COVID fiscal expansion, he suggests, offers a practical illustration of how large, debt-financed transfers — perceived as “gifts” rather than future tax liabilities — can shift expectations and generate inflationary pressures

Eric also discusses the steady drift towards fiscal dominance in the United States and the erosion of what he calls the “Hamilton norm” — the principle that deficits should ultimately be matched by future surpluses. He highlights the growing tension between stabilising inflation and stabilising public debt: when debt levels are high, raising interest rates to curb inflation mechanically increases debt-service costs, creating political and institutional strain. In his view, central banks cannot credibly deliver price stability in isolation if fiscal authorities do not restore a sustainable path for public finances.

Looking ahead, the discussion turns to the future of Federal Reserve leadership and the limits of central bank independence. Eric argues that truly independent monetary policy requires more candid acknowledgement of fiscal realities. Without clearer fiscal commitments, inflation control may require difficult trade-offs — or painful market discipline — before policy regimes revert to a more stable monetary-dominant equilibrium.

Eric Leeper is Paul Goodloe McIntire Professor of Economics at the University of Virginia, a Research Associate at the National Bureau of Economic Research, and a Visiting Scholar at the Mercatus Center. He has served as an external adviser to the Sveriges Riksbank and as a member of the Research Council of the Deutsche Bundesbank. His research focuses on the interaction of monetary and fiscal policy, inflation dynamics and sovereign debt sustainability.

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