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 when the fiscal authority is “active” or “dominant.” In the Heterogeneous Agent New Keynesian (HANK) paradigm, households are instead non-Ricardian, so deficits invariably drive aggregate demand, and thereby also inflation, now through classical wealth or liquidity effects. Because of this difference, HANK is free of the FTPL’s fragilities and controversies. Despite this difference, HANK actually reproduces the FTPL’s quantitative predictions regarding the relation between deficits and inflation, provided that two testable conditions are met: that marginal propensities to consume are high, consistent with microeconomic evidence; and that deficits are not accompanied by interest rate or tax hikes in the near term, as was the case post-2021.

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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