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Public debt, discretionary policy, and inflation persistence

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  • Paul Pichler

    (Oesterreichische Nationalbank)

  • Gerhard Sorger

    (University of Vienna)

  • Stefan Niemann

    (University of Essex)

Abstract

We describe a simple mechanism that generates inflation persistence in a standard sticky-price model of optimal fiscal and monetary policy. Key to this mechanism is that policies are decided under discretion. The government's discretionary incentive to erode the real value of nominal public debt by means of surprise inflation renders inflation expectations and, in further consequence, equilibrium inflation rates highly correlated with the stock of public debt. Debt, in turn, is highly persistent to allow for tax-smoothing in the face of disturbances and, due to the aforementioned correlation, this persistence carries over to inflation. Our analysis shows a non-monotonic effect of nominal rigidities on inflation persistence and reveals further important differences between optimal policies under discretion versus commitment. Most notably, government debt under discretion does not display the near random walk property familiar from the Ramsey literature.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 887.

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Date of creation: 2011
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Handle: RePEc:red:sed011:887

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Cited by:
  1. Volker Hahn, 2014. "Discretionary Policy and Multiple Equilibria in a New Keynesian Model," Working Paper Series of the Department of Economics, University of Konstanz, Department of Economics, University of Konstanz 2014-14, Department of Economics, University of Konstanz.
  2. Joost Röttger, 2014. "Monetary and Fiscal Policy with Sovereign Default," Working Paper Series in Economics, University of Cologne, Department of Economics 74, University of Cologne, Department of Economics.
  3. Campbell Leith & Ding Liu, 2014. "The in‡flation bias under Calvo and Rotemberg pricing," Working Papers, Business School - Economics, University of Glasgow 2014_06, Business School - Economics, University of Glasgow.

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