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Perceptions and misperceptions of fiscal inflation

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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 monetization, through which fiscal deficits directly affect inflation. The paper begins by pointing out similarities and differences between the Weimar Republic after World War I and the United States today. It 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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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 364.

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Length: 62 pages
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:bis:biswps:364

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Keywords: monetary-fiscal interactions; fiscal theory; monetization;

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Citations

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Cited by:
  1. Christos Shiamptanis, 2014. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," LCERPA Working Papers, Laurier Centre for Economic Research and Policy Analysis lm0063, Laurier Centre for Economic Research and Policy Analysis, revised Jun 2014.
  2. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers, International Monetary Fund 12/95, International Monetary Fund.
  3. Philip Turner, 2011. "Is the long-term interest rate a policy victim, a policy variable or a policy lodestar?," BIS Working Papers, Bank for International Settlements 367, Bank for International Settlements.
  4. António Afonso & Priscilla Toffano, 2013. "Fiscal regimes in the EU," Working Papers Department of Economics, ISEG - School of Economics and Management, Department of Economics, University of Lisbon 2013/10, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  5. Eric M. Leeper & Todd B. Walker, 2012. "Perceptions and Misperceptions of Fiscal Inflation," NBER Working Papers 17903, National Bureau of Economic Research, Inc.
  6. De Graeve, Ferre & Queijo von Heideken, Virginia, 2013. "Identifying Fiscal Inflation," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 273, Sveriges Riksbank (Central Bank of Sweden).
  7. William R. White, 2012. "Credit Crises and the Shortcomings of Traditional Policy Responses," OECD Economics Department Working Papers, OECD Publishing 971, OECD Publishing.
  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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