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Fiscal deficits and inflation risks: the role of fiscal and monetary policy regimes

Ryan Banerjee, Valerie Boctor, Aaron Mehrotra and Fabrizio Zampolli

No 1028, BIS Working Papers from Bank for International Settlements

Abstract: Using data from a panel of advanced economies over four decades, we show that the inflationary effect of fiscal deficits crucially depends on the prevailing fiscal-monetary policy regime. Under fiscal dominance, defined as a regime in which the government does not adjust the primary balance to stabilise debt and the central bank is less independent or puts less emphasis on price stability, the average effect on inflation of higher deficits is found to be up to five times larger than under monetary dominance. Under fiscal dominance, higher deficits also increase the dispersion of possible future inflationary outcomes, especially the probability of high inflation. Based on forecasts from our model, the high inflation experienced by many countries during the recovery from the Covid-19 pandemic appears more consistent with a regime of fiscal dominance than monetary dominance.

Keywords: fiscal deficit; inflation; fiscal policy regime; monetary policy regime; monetary policy independence (search for similar items in EconPapers)
JEL-codes: E31 E52 E62 E63 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2022-07
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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