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Public debt, discretionary policy, and inflation persistence

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  • Niemann, Stefan
  • Pichler, Paul
  • Sorger, Gerhard

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 implemented 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, allowing for tax-smoothing in the face of disturbances. Due to the aforementioned correlation, the persistence in debt carries over to inflation. Our analysis uncovers a non-monotonic effect of nominal rigidities on inflation persistence and shows that government debt under discretion does not display the near random walk property familiar from the Ramsey literature. A calibrated version of the model that incorporates a moderate degree of monopolistic competition and price stickiness is quantitatively consistent with the inflation dynamics experienced in the USA since the Volcker disinflation of the early 1980s.

Suggested Citation

  • Niemann, Stefan & Pichler, Paul & Sorger, Gerhard, 2013. "Public debt, discretionary policy, and inflation persistence," Journal of Economic Dynamics and Control, Elsevier, vol. 37(6), pages 1097-1109.
  • Handle: RePEc:eee:dyncon:v:37:y:2013:i:6:p:1097-1109
    DOI: 10.1016/j.jedc.2013.01.014
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    5. Sunder-Plassmann, Laura, 2020. "Infation, default and sovereign debt: The role of denomination and ownership," Journal of International Economics, Elsevier, vol. 127(C).
    6. Brendon, Charles & Ellison, Martin, 2018. "Time-consistently undominated policies," LSE Research Online Documents on Economics 87176, London School of Economics and Political Science, LSE Library.
    7. Leeper, E.M. & Leith, C., 2016. "Understanding Inflation as a Joint Monetary–Fiscal Phenomenon," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2305-2415, Elsevier.
    8. Joost Röttger, 2014. "Monetary and Fiscal Policy with Sovereign Default," Working Paper Series in Economics 74, University of Cologne, Department of Economics.
    9. Campbell Leith & Eric Leeper, 2016. "Understanding Inflation as a Joint Monetary-Fiscal Phenomenon," Working Papers 2016_01, Business School - Economics, University of Glasgow.
    10. Martin Ellison & Charles Brendon, 2015. "Time-Consistent Institutional Design," 2015 Meeting Papers 495, Society for Economic Dynamics.
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    More about this item

    Keywords

    Inflation dynamics; Persistence; Optimal fiscal and monetary policy; Lack of commitment;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • 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

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