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Public debt, discretionary policy, and inflation persistence

Author

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  • Paul Pichler

    (Oesterreichische Nationalbank)

  • Gerhard Sorger

    (University of Vienna)

  • Stefan Niemann

    (University of Essex)

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 decided 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 to allow for tax-smoothing in the face of disturbances and, due to the aforementioned correlation, this persistence carries over to inflation. Our analysis shows a non-monotonic effect of nominal rigidities on inflation persistence and reveals further important differences between optimal policies under discretion versus commitment. Most notably, government debt under discretion does not display the near random walk property familiar from the Ramsey literature.

Suggested Citation

  • Paul Pichler & Gerhard Sorger & Stefan Niemann, 2011. "Public debt, discretionary policy, and inflation persistence," 2011 Meeting Papers 887, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:887
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    2. Leeper, Eric M. & Leith, Campbell & Liu, Ding, 2021. "Optimal Time-Consistent Monetary, Fiscal and Debt Maturity Policy," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 600-617.
    3. Bolat, Süleyman & Tiwari, Aviral Kumar & Kyophilavong, Phouphet, 2017. "Testing the inflation rates in MENA countries: Evidence from quantile regression approach and seasonal unit root test," Research in International Business and Finance, Elsevier, vol. 42(C), pages 1089-1095.
    4. Wenxin Du & Carolin E. Pflueger & Jesse Schreger, 2016. "Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy," NBER Working Papers 22592, National Bureau of Economic Research, Inc.
    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.
    11. Roettger, Joost, 2019. "Discretionary monetary and fiscal policy with endogenous sovereign risk," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 44-66.
    12. Volker Hahn, 2014. "Discretionary Policy and Multiple Equilibria in a New Keynesian Model," Working Paper Series of the Department of Economics, University of Konstanz 2014-14, Department of Economics, University of Konstanz.

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    More about this item

    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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