Perceptions and Misperceptions of Fiscal Inflation
Todd B. Walker
Indiana University Bloomington - Department of Economics
Eric M. Leeper
Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER); Monash University, Department of Economics
December 1, 2011
BIS Working Paper No. 364
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 monetization, through which fiscal deficits directly affect inflation. The paper begins by pointing out similarities and differences between the Weimar Republic after World War I and the United States today. It 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.
Number of Pages in PDF File: 62
Keywords: monetary-fiscal interactions, fiscal theory, monetization
JEL Classification: E31, E52, E62, E63working papers series
Date posted: December 12, 2011
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