The Role of Fiscal Policy in Britain's Great Inflation

36 Pages Posted: 10 Nov 2014

See all articles by Jingwen Fan

Jingwen Fan

Jinan University

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Zhirong Ou

Cardiff University - Cardiff Business School

Date Written: November 2014

Abstract

We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model; the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the Orthodox model outperforms the FTPL. But the best account of the period assumes that expectations were a probability-weighted combination of the two regimes. Fiscal policy has a substantial role in this weighted model. A similar model accounts for the 1980s though the role of fiscal policy gets smaller.

Keywords: fiscal theory of the price level, identification, indirect inference, testing, UK inflation

JEL Classification: E31, E37, E62, E65

Suggested Citation

Fan, Jingwen and Minford, Patrick and Ou, Zhirong, The Role of Fiscal Policy in Britain's Great Inflation (November 2014). CEPR Discussion Paper No. DP10240. Available at SSRN: https://ssrn.com/abstract=2521461

Jingwen Fan

Jinan University ( email )

Huang Pu Da Dao Xi 601, Tian He District
Guangzhou, Guangdong 510632
China

Patrick Minford

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Zhirong Ou

Cardiff University - Cardiff Business School

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