Fiscal Populism and Monetary Policy Rules

We explore the historical link between populist regimes, fiscal monetization, and inflation, and how these links affect monetary policy in the 21st century. Using data for a large set of advanced economies and emerging markets since 1960, we show that, historically, left-leaning populist regimes are linked to increases in central bank lending to the central government, a gauge of deficit monetization. In turn, central bank lending is associated with marked increases in inflation. We show that past exposure to populism that relied on deficit monetization affects the conduct of monetary policy today. Countries with a history of deficit monetization and left-wing populist regimes systematically respond more strongly to deviations of inflation expectations from target. This effect persists even after controlling for the direct effect of past inflation on monetary policy rules. In the context of the literature of experienced learning, this novel finding sheds light on the persistence of past populist policies—central banks operating under the shadow of past populist regimes that relied on inflation-prone deficit monetization continue today needing to send stronger signals of their independence and commitment to price stability to effectively anchor inflation expectations.