Financing COVID-19 Deficits in Fiscally Dominant Economies: Is The Monetarist Arithmetic Unpleasant?

24 Pages Posted: 15 Jan 2021

Date Written: December 30, 2020

Abstract

The coronavirus pandemic of 2019-20 confronted fiscally dominant regimes around the world with the question of whether the large deficits caused by the health crisis should be monetized or financed by issuing debt. The unpleasant monetarist arithmetic of Sargent and Wallace (1981) states that in a fiscally dominant regime tighter money now can cause higher inflation in the future. In spite of the qualifier ‘unpleasant,’ this result is positive in nature, and, therefore, void of normative content. I analyze conditions under which it is optimal in a welfare sense for the central bank to delay inflation by issuing debt to finance part of the fiscal deficit. The analysis is conducted in the context of a model in which the aforementioned monetarist arithmetic holds, in the sense that if the government finds it optimal to delay inflation, it does so knowing that it would result in higher inflation in the future. The central result of the paper is that delaying inflation is optimal when the fiscal deficit is expected to decline over time.

Keywords: Optimal Monetary Policy, Inflation Tax, Fiscal Deficits, Public Debt

JEL Classification: E52, E61, E63

Suggested Citation

Uribe, Martin, Financing COVID-19 Deficits in Fiscally Dominant Economies: Is The Monetarist Arithmetic Unpleasant? (December 30, 2020). East Asian Economic Review Vol. 24, No. 4 (December 2020) 417-440, https://dx.doi.org/10.11644/KIEP.EAER.2020.24.4.386, Available at SSRN: https://ssrn.com/abstract=3766673 or http://dx.doi.org/10.2139/ssrn.3766673

Martin Uribe (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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