Deficits and Inflation: HANK meets FTPL

George-Marios Angeletos, Chen Lian and Christian Wolf

No 33102, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In the Fiscal Theory of the Price Level (FTPL), households are Ricardian, so fiscal deficits drive output and inflation only under hard-to-test assumptions about which policy authority is “active” or “dominant.” In the Heterogeneous Agent New Keynesian (HANK) paradigm, households are instead non-Ricardian, so deficits drive aggregate demand, and thereby also inflation, through classical wealth or liquidity effects. Because of this difference, HANK is free of FTPL’s fragilities and controversies. Despite this difference, HANK actually reproduces FTPL’s core empirical predictions regarding the relation between deficits and inflation. This is true even for the most extreme FTPL scenario, where unfunded deficits are financed entirely by inflation-induced debt erosion. In practice, however, deficit-financed fiscal stimuli can help expand output and thus tax revenue, substituting for debt erosion and moderating the associated inflationary pressures.

JEL-codes: E3 E6 (search for similar items in EconPapers)
Date: 2024-11
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
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