Working Paper: NBER ID: w30727
Authors: Francesco Bianchi; Renato Faccini; Leonardo Melosi
Abstract: We develop a new class of general equilibrium models with partially unfunded debt to propose a fiscal theory of persistent inflation. In response to business cycle shocks, the monetary authority controls inflation and the fiscal authority stabilizes debt. How- ever, the central bank accommodates unfunded fiscal shocks, causing persistent movements in inflation, output, and real interest rates. In an estimated quantitative model, fiscal inflation accounts for the bulk of inflation dynamics. In the aftermath of the pandemic, unfunded fiscal shocks sustain the recovery, but also cause a persistent increase in inflation. The model is able to predict the inflationary effects of the ARPA fiscal stimulus out of sample and with real time data.
Keywords: Fiscal Theory; Inflation; Unfunded Debt; Business Cycle
JEL Codes: E30; E50; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unfunded fiscal shocks (H69) | persistent increases in inflation (E31) |
| central bank accommodation (E58) | persistent increases in inflation (E31) |
| unfunded fiscal shocks (H69) | central bank accommodation (E58) |
| central bank accommodation (E58) | inflation persistence (E31) |
| unfunded fiscal shocks (H69) | feedback loop affecting real interest rates and output (E43) |
| unfunded fiscal shocks (H69) | deflation (without these shocks) (E31) |
| aggressive interest rate hikes by the Federal Reserve (E52) | stabilize unfunded debt (H69) |
| inflationary effects of ARPA fiscal stimulus (E62) | significant overshoot of inflation (E31) |