Perceptions and Misperceptions of Fiscal Inflation

This chapter examines alternative policy scenarios involving price-level changes induced by the fiscal theory. It is organized as follows. Section 7.2 uses a simple model to illustrate how the price level is determined in the conventional paradigm and in the fiscal theory. The conventional policy mix (Regime M) has monetary policy target inflation and fiscal policy stabilizes the value of debt. An alternative mix (Regime F) is available when governments issue nominal bonds. The chapter then describes how the maturity structure of nominal government bonds can alter the time series properties of inflation and lays out the precise role that monetary policy plays in a fiscal equilibrium. Having established that under Regime F policies monetary policy does not control inflation, Section 7.3 turns to plausible scenarios in which the central bank does not control inflation even in Regime M. Section 7.4 considers the empirical implications of monetary-fiscal policy interactions.