The Fiscal Transmission Mechanism of Inflation

American Business Review, forthcoming

23 Pages Posted: 9 Feb 2023 Last revised: 3 Mar 2023

See all articles by Robert Gmeiner

Robert Gmeiner

The Sunwater Institute; Methodist University

Sven R. Larson

Independent

Date Written: February 7, 2023

Abstract

The link between money creation and inflation has been theoretically demonstrated, but different inflation responses to Federal Reserve activity after the Great Recession and COVID recession showed the incomplete nature of the theory. We model a ``fiscal transmission mechanism'' whereby Federal Reserve purchases of Treasury securities lead to inflation as new dollars flow through fiscal deficits into the economy. In our model, other Federal Reserve activity generally lacks inflationary effects. Using a nonstructural vector autoregression approach, we test for the presence of this mechanism and offer near perfect predictions of the 2022 inflation rate using a time series extending back half a century. We explain the fiscal transmission mechanism and the reasons why other Federal Reserve activity lacks the same effects, and we propose an emphasis on controlling the money supply by limiting Federal Reserve purchases of Treasury securities as a better way to control inflation than setting an interest rate target.

Keywords: inflation, transmission mechanism, monetary policy, fiscal policy, budget deficits

JEL Classification: E63, E31, E58, H63

Suggested Citation

Gmeiner, Robert and Gmeiner, Robert and Larson, Sven R., The Fiscal Transmission Mechanism of Inflation (February 7, 2023). American Business Review, forthcoming, Available at SSRN: https://ssrn.com/abstract=4350855 or http://dx.doi.org/10.2139/ssrn.4350855

Robert Gmeiner (Contact Author)

The Sunwater Institute ( email )

12358 Parklawn Dr
North Bethesda, MD 20852
United States

HOME PAGE: http://www.sunwater.org

Methodist University ( email )

5400 Ramsey St
Fayetteville, NC 28311
United States

HOME PAGE: http://www.rgmeiner.com

Sven R. Larson

Independent ( email )

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