American Economic Review Vol. 108 No. 9 2018

Fiscal Foundations of Inflation: Imperfect Knowledge

Stefano Eusepi¹; Bruce Preston²

¹ Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045 (email: ) · ² University of Melbourne, FBE Building, 111 Barry Street, Carlton, VIC 3010 Australia (email: )

Abstract

This paper proposes a theory of the fiscal foundations of inflation based on imperfect knowledge and learning. Because imperfect knowledge breaks Ricardian equivalence, the scale and composition of the public debt matter for inflation. High and moderate duration debt generates wealth effects on consumption demand that impairs the intertemporal substitution channel of monetary policy: aggressive monetary policy is required to anchor inflation expectations. Counterfactual experiments conducted in an estimated model reveal that the US economy would have been substantially more volatile over the Great Inflation and Great Moderation periods if US debt levels had been those observed in Italy or Japan.

DOI

10.1257/aer.20131461

Volume

108

Issue

9

Pages

2551-2589

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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