Household Beliefs about Fiscal Dominance

Eric Mengus, Emanuel Mönch, Erwan Gautier and Philippe Andrade
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Eric Mengus: HEC Paris - Economics & Decision Sciences
Emanuel Mönch: Frankfurt School of Finance & Management; Centre for Economic Policy Research (CEPR)
Erwan Gautier: Bank of France Research Center
Philippe Andrade: Federal Reserve Bank of Boston

No 1603, HEC Research Papers Series from HEC Paris

Abstract: We study beliefs about fiscal dominance in a survey of German households. We first use a randomized controlled trial to identify how fiscal news impact individual debt-to-GDP and inflation expectations. We document that the link between debt and inflation crucially depends on individuals' views about the fiscal space. News leading individuals to expect higher debt-to-GDP ratios make them more likely to revise upward their inflation expectations. These average effects are due to individuals who think that fiscal resources are more stretched than others. In contrast, individuals who think there is fiscal space do not associate debt with inflation. We then rationalize these results in a New Keynesian model where agents have heterogeneous beliefs about the fiscal space. We show that the heterogeneity of beliefs implies a policy trade-off for the central bank. Agents who expect fiscal dominance in the future exert upward pressure on inflation. An active central bank may choose to partially tolerate this higher inflation due to the real costs of completely stabilizing prices.

Keywords: inflation expectations; fiscal and monetary policy; heterogeneous beliefs; randomized controlled trial; survey data (search for similar items in EconPapers)
JEL-codes: D84 E31 E52 H60 (search for similar items in EconPapers)
Pages: 78 pages
Date: 2025-03-25, Revised 2025-03-25
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1603

DOI: 10.2139/ssrn.5192275

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