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Government deficits, wealth effects and the price level in an optimizing model

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  • Annicchiarico, Barbara

Abstract

This paper investigates the inflationary effects of fiscal policy in an optimizing general equilibrium monetary model with capital accumulation, flexible prices and wealth effects. The model is calibrated to Euro Area quarterly data. Simulation results show that government deficits, high debt level and slow fiscal adjustment adversely affect price stability in the presence of an independent monetary authority adopting a monetary targeting regime. The mechanism through which fiscal policy affects the dynamics of the price level presents monetarist properties, since the price level is determined in the monetary market. The effects produced by fiscal expansions on price dynamics are due to the behaviour of consumers, facing a positive probability of death and sharing the burden of fiscal adjustment with future generations. Fiscal variables are shown to influence the consumption plan of individuals and the demand for real money balances, thus affecting the equilibrium conditions in the money market where the price level is determined. JEL Classification: E31, E62

Suggested Citation

  • Annicchiarico, Barbara, 2003. "Government deficits, wealth effects and the price level in an optimizing model," Working Paper Series 285, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2003285
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    2. Vratislav Izák, 2005. "Fiscal Deficits and Inflation in the Transition Countries," Prague Economic Papers, Prague University of Economics and Business, vol. 2005(1), pages 3-16.

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    More about this item

    Keywords

    fiscal policy and government debt; price stability;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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