Working Paper: NBER ID: w25811
Authors: John H. Cochrane
Abstract: Unexpected inflation devalues nominal government bonds. It must therefore correspond to a decline in expected future surpluses, or a rise in their discount rates, so that the real value of debt equals the present value of surpluses. I measure each component using a vector autoregression, via responses to inflation, recession, surplus and discount rate shocks. Discount rates account for much inflation variation, for the cyclical pattern of inflation, and why persistent deficits often do not cause inflation. Long-term debt is important. In response to a fiscal shock, smooth inflation slowly devalues outstanding long-termbonds.
Keywords: inflation; government debt; fiscal policy; discount rates
JEL Codes: E31; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unexpected inflation (E31) | decline in expected future surpluses (H62) |
| unexpected inflation (E31) | rise in discount rates (E43) |
| higher inflation (E31) | lower surplus-to-GDP ratios (H62) |
| higher inflation (E31) | higher discount rates (E43) |
| changes in discount rates (E43) | inflationary effect (E31) |
| changes in growth (O41) | inflationary effect (E31) |
| slow inflation (E31) | devalue long-term bonds (E43) |
| persistent deficits (H62) | low returns (G19) |
| low returns (G19) | restore value of debt (H63) |
| strong correlation between discount rates and deficits (E43) | absence of inflation (E31) |