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Inflation Targeting under Fiscal Fragility

Author

Listed:
  • Aloisio Araujo
  • Vitor Costa
  • Paulo Lins
  • Rafael Santos
  • Serge de Valk

Abstract

We propose a model to study an inflation-targeting regime under a high government debt burden. We assume that an altruistic policymaker chooses debt issuance, inflation, and public expenditure, while private agents dislike inflation and finance the government. We show that equilibrium inflation depends on debt level: (i) on-target when debt is low; (ii) above the target when debt is high; (iii) either above or on-target in between, a zone that we named fiscal fragility. Equilibrium inflation also depends on the target level: A higher target may improve welfare by preventing fiscal fragility and reducing debt-rollover costs.

Suggested Citation

  • Aloisio Araujo & Vitor Costa & Paulo Lins & Rafael Santos & Serge de Valk, 2026. "Inflation Targeting under Fiscal Fragility," American Economic Journal: Macroeconomics, American Economic Association, vol. 18(2), pages 292-331, April.
    • Handle: RePEc:aea:aejmac:v:18:y:2026:i:2:p:292-331
    DOI: 10.1257/mac.20230291
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    References listed on IDEAS

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    1. Campos, Eduardo Lima & Cysne, Rubens Penha, 2018. "Welfare cost of Inflation in Brazil: an approach with time-varying cointegration and Kalman filter," FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) 801, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil).
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      More about this item

      JEL classification:

      • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
      • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
      • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
      • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
      • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
      • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
      • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development

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