Inflation Dynamics: The Role of Public Debt and Policy Regimes

67 Pages Posted: 29 Nov 2013

See all articles by Saroj Bhattarai

Saroj Bhattarai

Pennsylvania State University - Department of Economics

Jae Won Lee

University of Virginia - Department of Economics

Woong Yong Park

Seoul National University

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2013

Abstract

We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the response of inflation to non-policy shocks. Moreover, a higher level of government debt leads to a greater response of inflation while a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy parameters matter for inflation dynamics, but because of equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a quantitative model.

Keywords: Time-varying inflation target, Inflation response, Public debt, Monetary and fiscal policy regimes, Monetary and fiscal policy stances, DSGE model

JEL Classification: E31, E52, E63

Suggested Citation

Bhattarai, Saroj and Lee, Jae Won and Park, Woong Yong, Inflation Dynamics: The Role of Public Debt and Policy Regimes (November 1, 2013). CAMA Working Paper No. 75/2013, Available at SSRN: https://ssrn.com/abstract=2360880 or http://dx.doi.org/10.2139/ssrn.2360880

Saroj Bhattarai

Pennsylvania State University - Department of Economics ( email )

Harrisburg, PA
United States

Jae Won Lee

University of Virginia - Department of Economics ( email )

237 Monroe Hall
P.O. Box 400182
Charlottesville, VA 22904-418
United States

Woong Yong Park (Contact Author)

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

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