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Perceptions and misperceptions of fiscal inflation

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  • Eric M. Leeper
  • Todd B. Walker

Abstract

The Great Recession and worldwide financial crisis have exploded fiscal imbalances and brought fiscal policy and inflation to the forefront of policy concerns. Those concerns will only grow as aging populations increase demands on government expenditures in coming decades. It is widely perceived that fiscal policy is inflationary if and only if it leads the central bank to print new currency to monetize deficits. Monetization can be inflationary. But it is a misperception that this is the only channel for fiscal inflations. Nominal bonds, the predominant form of government debt in advanced economies, derive their value from expected future nominal primary surpluses and money creation; changes in the price level can align the market value of debt to its expected real backing. This introduces a fresh channel, not requiring monetization, through which fiscal deficits directly affect inflation. The paper begins by pointing out similarities and differences between the Weimar Republic after World War I and the United States today. It describes various ways in which fiscal policy can directly affect inflation and explains why these fiscal effects are difficult to detect in time series data.

Suggested Citation

  • Eric M. Leeper & Todd B. Walker, 2011. "Perceptions and misperceptions of fiscal inflation," BIS Working Papers 364, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:364
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Chowdhury, Mohammad Tarequl Hasan & Bhattacharya, Prasad Sankar & Mallick, Debdulal & Ulubaşoğlu, Mehmet Ali, 2016. "Exchange rate regimes and fiscal discipline: The role of trade openness," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 106-128.
    2. Philip Turner, 2011. "Is the long-term interest rate a policy victim, a policy variable or a policy lodestar?," BIS Working Papers 367, Bank for International Settlements.
    3. Qureshi, Irfan, 2015. "Monetary Policy Shifts and Central Bank Independence," MPRA Paper 81646, University Library of Munich, Germany, revised Sep 2017.
    4. Eric M. Leeper & Todd B. Walker, 2012. "Perceptions and Misperceptions of Fiscal Inflation," NBER Chapters,in: Fiscal Policy after the Financial Crisis, pages 255-299 National Bureau of Economic Research, Inc.
    5. António AFONSO & Priscilla TOFFANO, 2013. "Fiscal regimes in the EU," Working Papers Department of Economics ces13.06, KU Leuven, Faculty of Economics and Business, Department of Economics.
    6. De Graeve, Ferre & Queijo von Heideken, Virginia, 2015. "Identifying fiscal inflation," European Economic Review, Elsevier, pages 83-93.
    7. William R. White, 2012. "Credit Crises and the Shortcomings of Traditional Policy Responses," OECD Economics Department Working Papers 971, OECD Publishing.
    8. Michael Bordo & Robert N McCauley, 2017. "Triffin: dilemma or myth?," BIS Working Papers 684, Bank for International Settlements.
    9. Christos Shiamptanis, 2015. "Risk Assessment Under A Nonlinear Fiscal Policy Rule," Economic Inquiry, Western Economic Association International, vol. 53(3), pages 1539-1555, July.
    10. repec:col:000107:015644 is not listed on IDEAS
    11. Joanna Mackiewicz­‑Łyziak, 2014. "Wpływ długu publicznego na oczekiwania inflacyjne konsumentów w Europie," Gospodarka Narodowa, Warsaw School of Economics, issue 5, pages 113-132.
    12. Manmohan Singh & Peter Stella, 2012. "Money and Collateral," IMF Working Papers 12/95, International Monetary Fund.
    13. repec:bdr:ensayo:v:35:y:2017:i:83:p:161-187 is not listed on IDEAS
    14. Hernán Rincón & Diego Rodríguez & Jorge Toro & Santiago Téllez, 2017. "FISCO: modelo fiscal para Colombia," Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(83), pages 161-187, Junio.
    15. Roseline Nyakerario Misati & Esman Morekwa Nyamongo & Lucas Kamau Njoroge & Sheila Kaminchia, 2012. "Feasibility of inflation targeting in an emerging market: evidence from Kenya," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(2), pages 146-159, May.

    More about this item

    Keywords

    monetary-fiscal interactions; fiscal theory; monetization;

    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
    • 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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