Working Paper: CEPR ID: DP431
Authors: Maurice Obstfeld
Abstract: This paper shows how a government that cannot make credible policy commitments might manage its exchange rate and fiscal stance in a world of rational expectations. The dynamic-game model developed here potentially can generate diverse patterns of macroeconomic behaviour, patterns that differ as a result of assumed differences in government objectives. Under some types of government, the ongoing strategic interaction between the public and private sectors leads to a disinflationary outcome. Other governments may push the economy into a spiral of rising debt and inflation.
Keywords: currency depreciation; public debt; tax-smoothing models; markov-perfect equilibrium; dynamic games
JEL Codes: 431
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government credibility (H12) | Inflation expectations (E31) |
| Government actions (H11) | Inflation expectations (E31) |
| Rising debt levels (H63) | Increased inflation (E31) |
| Government debt reduction (H63) | Lower inflation expectations (E31) |
| Misalignment of government discount rate and market interest rate (E43) | Debt-inflation spiral (E31) |