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Understanding Inflation Dynamics: The Role of Government Expenditures

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  • Chang Liu
  • Yinxi Xie

Abstract

This paper studies the impact government expenditure has on inflation by examining an augmented Phillips curve implied from a structural New Keynesian model. Our estimation results, based on external instruments, show that the augmented Phillips curve has a flatter slope than the canonical specification and that government expenditure has a negative coefficient. Changes in government expenditure account for a substantial portion of inflation variations and provide new insights into the “missing disinflation” puzzle. We also find that inflation and inflation expectations respond negatively to fiscal spending shocks, reaffirming the supply-side channel through which inflation responds to fiscal expansions.

Suggested Citation

  • Chang Liu & Yinxi Xie, 2023. "Understanding Inflation Dynamics: The Role of Government Expenditures," Staff Working Papers 23-30, Bank of Canada.
    • Handle: RePEc:bca:bocawp:23-30
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    References listed on IDEAS

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    More about this item

    Keywords

    Central bank research; Fiscal policy; Inflation and prices;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • 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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