Abstract: What decides the overall price level, as well as how to control the inflation has always been the concern of economists and the government departments of decision-making. The fiscal theory of the price level recently raised emphasizes the impact of changes in fiscal policy on the price level. Based on the theory,this paper chooses quarterly data of government debt and price level in 1998-2012, and makes an empirical test of the inflationary effect of the fiscal policy in China from one side by using Markov regime switching model. Our study found that the effect of proactive fiscal policy on the price level is not consistent. Most of the time before the fourth quarter of 2008, the inflation risk arising from the proactive fiscal policy is insignificant; but after 1998, the proactive fiscal policy has a significant inflationary effect on the price level. Therefore, improvement of current fiscal position and rational use of fiscal policy may be a better choice when adopting policies to deal with inflation.

Keyword: government debt; inflation; Markov regime switching model