Fiscal Foundations of Inflation: Imperfect Knowledge
- (pp. 2551-89)
Abstract
This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence, the scale and composition of the public debt matter for inflation. High and moderate duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments conducted in an estimated model reveal that the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods if US debt levels had been those observed in Italy or Japan.Citation
Eusepi, Stefano, and Bruce Preston. 2018. "Fiscal Foundations of Inflation: Imperfect Knowledge." American Economic Review, 108 (9): 2551-89. DOI: 10.1257/aer.20131461Additional Materials
JEL Classification
- D84 Expectations; Speculations
- E31 Price Level; Inflation; Deflation
- E32 Business Fluctuations; Cycles
- E52 Monetary Policy
- E62 Fiscal Policy
- H63 National Debt; Debt Management; Sovereign Debt