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Inflation Dynamics: The Role of Public Debt and Policy Regimes

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  • Woong Yong Park

    (University of Hong Kong)

  • Jae Won Lee

    (Rutgers University)

  • Saroj Bhattarai

    (Pennsylvania State University)

Abstract

We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the equilibrium response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the equilibrium response of inflation to non-policy shocks. Moreover, a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy stances affect inflation dynamics, but because of a role for self-fulfilling beliefs due to equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a richer quantitative model.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 359.

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Date of creation: 2013
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Handle: RePEc:red:sed013:359

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  1. Thomas Lubik & Frank Schorfheide, 2002. "Testing for Indeterminacy:An Application to U.S. Monetary Policy," Economics Working Paper Archive 480, The Johns Hopkins University,Department of Economics, revised Jun 2003.
  2. Thomas Sargent & Noah Williams & Tao Zha, 2006. "Shocks and Government Beliefs: The Rise and Fall of American Inflation," American Economic Review, American Economic Association, vol. 96(4), pages 1193-1224, September.
  3. Saroj Bhattarai & Jae Won Lee & Woong Yong Park, 2012. "Monetary-Fiscal Policy Interactions and Indeterminacy in Postwar US Data," American Economic Review, American Economic Association, vol. 102(3), pages 173-78, May.
  4. 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.
  5. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
  6. Andrea Tambalotti & Andrea Ferrero & Vasco Curdia, 2010. "Evaluating Interest Rate Rules in an Estimated DSGE Model," 2010 Meeting Papers 402, Society for Economic Dynamics.
  7. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  8. Woong Yong Park & Jae Won Lee & Saroj Bhattarai, 2012. "Policy Regimes, Policy Shifts, and U.S. Business Cycles," 2012 Meeting Papers 287, Society for Economic Dynamics.
  9. Kim, Soyoung, 2003. "Structural Shocks And The Fiscal Theory Of The Price Level In The Sticky Price Model," Macroeconomic Dynamics, Cambridge University Press, vol. 7(05), pages 759-782, November.
  10. Francesco Bianchi, 2011. "Monetary/Fiscal Policy Mix and Agents' Beliefs," 2011 Meeting Papers 156, Society for Economic Dynamics.
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Cited by:
  1. Anna Florio & Alessandro Gobbi, 2014. "Learning the Fiscal Monetary Interaction under Trend Infl?ation," DEM Working Papers Series 068, University of Pavia, Department of Economics and Management.

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