Journal article
Fiscal Foundations of Inflation: Imperfect Knowledge
Stefano Eusepi, B Preston
American Economic Review | American Economic Association | Published : 2018
DOI: 10.1257/aer.20131461
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 Ja..
View full abstractGrants
Awarded by Australian Research Council
Funding Acknowledgements
This paper was accepted to the AER under the guidance of Martin Eichenbaum, Coeditor. The authors are indebted to John Cochrane, Eric Leeper, and our discussants Kosuke Aoki, Francesco Bianchi, Pedro Gomes-Porqueras, Chris Sims, Leopold von Thadden, and three anonymous referees for detailed comments and exchange of ideas. Klaus Adam, Leon Berkelmans, Bill Branch, Marc Giannoni, Sylvain Leduc, Fabio Milani, Ricardo Reis, and John Williams are also thanked for useful discussions. The ideas contained herein also benefitted from comments by seminar participants at numerous universities and conferences. We thank Sara Sahahanaghi and Rujun Han for excellent research assistance. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. The usual caveat applies. Preston acknowledges research support from the Australian Research Council, under the grant FT130101599.