Budget Deficits and Inflation: A Theoretical and Empirical Survey

Japan's fiscal position is deteriorating continuously, and some argue that a debt write-off through managed inflation will be inevitable if public debt is to increase at the present pace. This article will first examine if inflation is an inevitable component of the attempt to solve the current government debt problem by looking at the history of debt reduction in other countries. Next, it will evaluate the economic theory on the interdependence between fiscal and monetary policies in light of the historical experience of inflation. In so doing, it finds that the gold standard imposed discipline on both fiscal and monetary policies while under the floating exchange rate regime budget institutions and the central bank system served as a guidepost to economic policy-making as an alternative to the gold standard. Based upon these theoretical historical and institutional findings, it will conclude by reflecting on the ways in which the experience of other countries can be useful for evaluating Japan's situation.