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Perceptions and Misperceptions of Fiscal Inflation

In: Fiscal Policy after the Financial Crisis

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  • Eric M. Leeper
  • Todd B. Walker

Abstract

The Great Recession and worldwide financial crisis have exploded fiscal imbalances and brought fiscal policy and inflation to the forefront of policy concerns. Those concerns will only grow as aging populations increase demands on government expenditures in coming decades. It is widely perceived that fiscal policy is inflationary if and only if it leads the central bank to print new currency to monetize deficits. Monetization can be inflationary. But it is a misperception that this is the only channel for fiscal inflations. Nominal bonds, the predominant form of government debt in advanced economies, derive their value from expected future nominal primary surpluses and money creation; changes in the price level can align the market value of debt to its expected real backing. This introduces a fresh channel, not requiring explicit monetization, through which fiscal deficits directly affect inflation. The paper describes various ways in which fiscal policy can directly affect inflation and explains why these fiscal effects are difficult to detect in time series data.

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This chapter was published in:

  • Alberto Alesina & Francesco Giavazzi, 2013. "Fiscal Policy after the Financial Crisis," NBER Books, National Bureau of Economic Research, Inc, number ales11-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 12644.

    Handle: RePEc:nbr:nberch:12644

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    Cited by:
    1. Afonso, António & Toffano, Priscilla, 2013. "Fiscal regimes in the EU," Working Paper Series, European Central Bank 1529, European Central Bank.
    2. De Graeve, Ferre & Queijo von Heideken, Virginia, 2013. "Identifying Fiscal Inflation," Working Paper Series 273, Sveriges Riksbank (Central Bank of Sweden).
    3. William R. White, 2012. "Credit Crises and the Shortcomings of Traditional Policy Responses," OECD Economics Department Working Papers 971, OECD Publishing.
    4. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
    5. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers 12/95, International Monetary Fund.
    6. Philip Turner, 2011. "Is the long-term interest rate a policy victim, a policy variable or a policy lodestar?," BIS Working Papers 367, Bank for International Settlements.
    7. Christos Shiamptanis, 2014. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," LCERPA Working Papers lm0063, Laurier Centre for Economic Research and Policy Analysis, revised Jun 2014.
    8. Roseline Nyakerario Misati & Esman Morekwa Nyamongo & Lucas Kamau Njoroge & Sheila Kaminchia, 2012. "Feasibility of inflation targeting in an emerging market: evidence from Kenya," Journal of Financial Economic Policy, Emerald Group Publishing, Emerald Group Publishing, vol. 4(2), pages 146-159, June.

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