Working Paper: CEPR ID: DP18260
Authors: Greg Kaplan; Georgios Nikolakoudis; Giovanni Violante
Abstract: We study equilibria in a heterogeneous-agent incomplete-market economy with nominal government debt and flexible prices. Unlike in representative agent economies, steady-state equilibria exist when the government runs persistent deficits, provided that the level of deficits is not too large. In these equilibria, the real interest rate is below the growth rate of the economy. We quantify the maximum sustainable deficit for the US and show that it is lower under more redistributive tax and transfer systems. With constant primary deficits, there exist two steady-states, and the price level and inflation are not uniquely determined. We describe alternative policy settings that deliver uniqueness. We conduct quantitative experiments to illustrate how redistribution and precautionary saving amplify price level increases in response to fiscal helicopter drops, deficit expansions, and loose monetary policy. We show that rising primary deficits can account for a decline in the long-run real interest rate, leading to higher inflation for any given monetary policy. Our work highlights the role of household heterogeneity and market incompleteness in determining inflation.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| degree of redistribution in tax and transfer systems (H23) | maximum sustainable deficit (H62) |
| fiscal helicopter drops (E62) | upward pressure on price levels (E31) |
| deficit expansions (H62) | upward pressure on price levels (E31) |
| increased consumption among lower-wealth households (D12) | upward pressure on price levels (E31) |
| increasing primary deficits (H62) | declining long-run real interest rates (E43) |
| declining long-run real interest rates (E43) | higher inflation (E31) |
| increasing primary deficits (H62) | higher inflation (E31) |