Debt, Deficits, and Inflation
Paper Session
Sunday, Jan. 5, 2025 8:00 AM - 10:00 AM (PST)
- Chair: Chen Lian, University of California-Berkeley
Fiscal Influences on Inflation in OECD Countries, 2020-2022
Abstract
The fiscal theory of the price level (FTPL) has been active for 30 years, and the interest in this theory grew with the recent global surges in inflation and government spending. This study applies the FTPL to 37 OECD countries for 2020-2022. The theory’s centerpiece is the government’s intertemporal budget constraint, which relates a country’s inflation rate in 2020 2022 (relative to a baseline rate) to a composite government-spending variable. This variable equals the cumulative increase in the ratio of government expenditure to GDP from 2020 to 2022, divided by the ratio of public debt to GDP in 2019 and the duration of the debt in 2019. This specification has substantial explanatory power for recent inflation rates across 20 non-Euro-zone countries and an aggregate of 17 Euro-zone countries. The estimated coefficients of the composite spending variable are significantly positive, implying that 40-50% of effective government financing came from the inverse effect of unexpected inflation on the real value of public debt, whereas 50 60% reflected conventional public finance (increases in current or future taxes or cuts in future spending). Within the Euro area, inflation reacts mostly to the area-wide government-spending variable, not to individual values.What about Japan?
Abstract
As a result of the BoJ's large-scale asset purchases, the consolidated Japanese government borrows mostly at the floating rate from households and invests in longer-duration risky assets to earn an extra 3% of GDP. We quantify the impact of Japan's low-rate policies on its government and households. Because of the duration mismatch on the government balance sheet, the government's fiscal space expands when real rates decline, allowing the government to keep its promises to older Japanese households. A typical younger Japanese household does not have enough duration in its portfolio to continue to finance its spending plan and will be worse off. Low-rate policies tax younger, poorer and less financially sophisticated households.Monetary Policy and Fiscal-led Inflation in Emerging Markets
Abstract
I study monetary policy and inflation in emerging markets and the interaction with fiscal policy. I measure monetary policy shocks—unanticipated changes in monetary policy—using changes in exchange rates around monetary policy announcements. I validate this approach against existing monetary policy shocks. I find that in response to an unanticipated rise in interest rates—a monetary policy tightening—inflation increases and output falls in emerging markets. This inflation response is opposite the one generally found for advanced economies. I show the results are in line with high-frequency changes in inflation expectations. I develop a small open economy New Keynesian model with monetary and fiscal policy interactions. I show a fiscal-led policy mix, i.e., a weak fiscal policy reaction of taxes to changes in government debt and accommodative monetary policy, can explain the increase in inflation. The estimated quantitative model finds a fiscal-led policy mix in emerging markets. The fiscal-led policy mix is supported by the effect of U.S. monetary policy shocks on emerging markets. I also study optimal monetary policy conditional on a fiscal-led policy regime.JEL Classifications
- E3 - Prices, Business Fluctuations, and Cycles
- E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook