Working Paper: CEPR ID: DP6792
Authors: Thomas J. Sargent; Joseph Zeira
Abstract: From 1970 to 1985, Israel experienced high inflation. It rose in three jumps to new plateaus and eventually exceeded 400% per annum. This paper claims that anticipated monetary and fiscal effects of a massive government bailout of owners of fallen bank shares caused the last big jump in inflation that occurred in October 1983. Bank shares had just collapsed after a scandal in which it was revealed that banks had long manipulated their share prices. The government promised to reimburse innocent owners for the diminished value of their bank shares, but only after four or five years. The public believed that promise and public debt therefore implicitly increased by a large amount. That implied future monetary expansions. Because that was foreseen, inflation immediately rose as predicted by the unpleasant monetarist arithmetic of Sargent and Wallace (1981).
Keywords: inflation; inflation tax; public debt; rational expectations
JEL Codes: E31; E50; H60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government bailout (H81) | public debt (H63) |
| public debt (H63) | anticipations of future monetary expansion (E49) |
| anticipations of future monetary expansion (E49) | inflation (E31) |
| government bailout (H81) | inflation (E31) |