Working Paper: NBER ID: w17903
Authors: Eric M. Leeper; Todd B. Walker
Abstract: The Great Recession and worldwide financial crisis have exploded fiscal imbalances and brought fiscal policy and inflation to the forefront of policy concerns. Those concerns will only grow as aging populations increase demands on government expenditures in coming decades. It is widely perceived that fiscal policy is inflationary if and only if it leads the central bank to print new currency to monetize deficits. Monetization can be inflationary. But it is a misperception that this is the only channel for fiscal inflations. Nominal bonds, the predominant form of government debt in advanced economies, derive their value from expected future nominal primary surpluses and money creation; changes in the price level can align the market value of debt to its expected real backing. This introduces a fresh channel, not requiring explicit monetization, through which fiscal deficits directly affect inflation. The paper describes various ways in which fiscal policy can directly affect inflation and explains why these fiscal effects are difficult to detect in time series data.
Keywords: Fiscal Policy; Inflation; Monetary Policy
JEL Codes: E31; E52; E62; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal policy (E62) | Inflation (E31) |
| Nominal bonds (G12) | Value derived from expected future surpluses and money creation (E19) |
| Fiscal deficits (H68) | Inflation (E31) |
| Current and expected deficits (H68) | Inflation (E31) |
| Monetary policy actions (E52) | Inflation control (E64) |
| Fiscal policy actions (E62) | Monetary policy control of inflation (E64) |