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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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References

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  1. Eusepi, Stefano & Preston, Bruce, 2011. "Learning the fiscal theory of the price level: Some consequences of debt-management policy," Journal of the Japanese and International Economies, Elsevier, vol. 25(4), pages 358-379.
  2. Troy Davig & Eric M. Leeper, 2005. "Fluctuating Macro Policies and the Fiscal Theory," NBER Working Papers 11212, National Bureau of Economic Research, Inc.
  3. Troy Davig & Eric M. Leeper, 2009. "Monetary-fiscal policy interactions and fiscal stimulus," Research Working Paper RWP 09-12, Federal Reserve Bank of Kansas City.
  4. Alexander W. Richter, 2013. "The Fiscal Limit and Non-Ricardian Consumers," Auburn Economics Working Paper Series auwp2013-19, Department of Economics, Auburn University.
  5. Marco Bassetto, 2002. "A Game-Theoretic View of the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 70(6), pages 2167-2195, November.
  6. Eric M. Leeper & Todd B. Walker, 2011. "Fiscal Limits in Advanced Economies," NBER Working Papers 16819, National Bureau of Economic Research, Inc.
  7. Daniel, Betty C. & Shiamptanis, Christos, 2012. "Fiscal risk in a monetary union," European Economic Review, Elsevier, vol. 56(6), pages 1289-1309.
  8. Davig, Troy & Leeper, Eric M. & Walker, Todd B., 2011. "Inflation and the fiscal limit," European Economic Review, Elsevier, vol. 55(1), pages 31-47, January.
  9. George J. Hall & Thomas J. Sargent, 2010. "Interest rate risk and other determinants of post WWII U.S. government debt/GDP dynamics," Working Papers 01, Brandeis University, Department of Economics and International Businesss School.
  10. Troy Davig & Eric M. Leeper & Todd B. Walker, 2010. ""Unfunded liabilities" and uncertain fiscal financing," Research Working Paper RWP 10-09, Federal Reserve Bank of Kansas City.
  11. Andreas Schabert, 2009. "Monetary Policy under a Fiscal Theory of Sovereign Default," Tinbergen Institute Discussion Papers 09-093/2, Tinbergen Institute.
  12. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  13. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  14. David B. Gordon & Eric M. Leeper, 2002. "The Price Level, the Quantity Theory of Money, and the Fiscal Theory of the Price Level," NBER Working Papers 9084, National Bureau of Economic Research, Inc.
  15. Michael D. Bordo & Pierre-Cyrille Hautcoeur, 2003. "Why didn't France follow the British Stabilization after World War One?," NBER Working Papers 9860, National Bureau of Economic Research, Inc.
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Cited by:
  1. 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.
  2. António Afonso & Priscilla Toffano, 2013. "Fiscal regimes in the EU," Working Papers Department of Economics 2013/10, ISEG - School of Economics and Management, Department of Economics, University of Lisbon.
  3. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers 12/95, International Monetary Fund.
  4. 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, vol. 4(2), pages 146-159, June.
  5. Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  6. William R. White, 2012. "Credit Crises and the Shortcomings of Traditional Policy Responses," OECD Economics Department Working Papers 971, OECD Publishing.

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