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  4. September 2018
  5. Fiscal Foundations of Inflation: Imperfect Knowledge

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Fiscal Foundations of Inflation: Imperfect Knowledge

  • Stefano Eusepi
  • Bruce Preston
American Economic Review
vol. 108, no. 9, September 2018
(pp. 2551–89)
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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.

Citation

Eusepi, Stefano, and Bruce Preston. 2018. "Fiscal Foundations of Inflation: Imperfect Knowledge." American Economic Review 108 (9): 2551–89. DOI: 10.1257/aer.20131461

Additional Materials

JEL Classification

  • D84 Expectations; Speculations
  • E31 Price Level; Inflation; Deflation
  • E32 Business Fluctuations; Cycles
  • E52 Monetary Policy
  • E62 Fiscal Policy
  • H63 National Debt; Debt Management; Sovereign Debt