Is it Time for Some Unpleasant Monetarist Arithmetic?
18 Pages Posted: 14 Jul 2021 Last revised: 6 Jul 2022
Date Written: July, 2021
Abstract
Sargent and Wallace (1981) published "Some Unpleasant Monetarist Arithmetic" 40 years ago. Their central message was that a central bank may not have the power to determine the long-run rate of inflation without fiscal support. In a policy regime where the fiscal authority is non-Ricardian, an attempt on the part of the central bank to lower inflation may end up backfiring. I develop a structural model to illustrate this result through the use of a diagram. In addition, I use the model to explain how low inflation, low interest rates, and high primary budget deficits can coexist. I also use the model to explain why it is easier for a central bank to lower inflation than to raise it. I conclude with some recommendations for state-contingent monetary policy.
Keywords: interest rates, monetary policy, inflation, budget deficits
JEL Classification: E4, E5, E6
Suggested Citation: Suggested Citation