A fiscal theory of persistent inflation

Francesco Bianchi, Renato Faccini, Leonardo Melosi

We develop a new class of general equilibrium models with partially unfunded debt to propose a fiscal theory of persistent inflation. In response to business cycle shocks, the monetary authority controls inflation, and the fiscal authority stabilizes debt. However, the central bank accommodates unfunded fiscal shocks, causing persistent movements in inflation, output, and real interest rates. In an estimated quantitative model, fiscal inflation accounts for the bulk of inflation dynamics. In the aftermath of the pandemic, unfunded fiscal shocks sustain the recovery, but also cause a persistent increase in inflation. The model is able to predict the inflationary effects of the ARPA fiscal stimulus out of sample and using real time data.

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Year of publication:	[2023]
Authors:	Bianchi, Francesco ; Faccini, Renato ; Melosi, Leonardo
Publisher:	Copenhagen : Danmarks Nationalbank
Subject:	Unfunded fiscal spending \| persistent inflation \| large public debt \| inflation risk \| shock-specific rule \| Öffentliche Schulden \| Public debt \| Inflation \| Finanzpolitik \| Fiscal policy \| Finanzwissenschaft \| Public economics \| Geldpolitik \| Monetary policy \| Schock \| Shock \| Inflationstheorie \| Inflation theory \| Öffentliche Ausgaben \| Public expenditure \| Regelbindung versus Diskretion \| Rules versus discretion \| Inflationsbekämpfung \| Anti-inflation policy