A Fiscal Theory of Hyperdeflations? Some Surprising Monetarist Arithmetic

Willem Buiter

Oxford Economic Papers, 1987, vol. 39, issue 1, 111-18

Abstract: For the range of "small" government deficits for which two stationary solutions exist, an increase in the deficit reduces the long-run rate of inflation if the locally-stable (high inflation) stationary equilibrium is chosen, increases it if the locally- unstable (low inflation) equilibrium is chosen. Explosive, unstable behavior always involves a steadily increasing negative rate of inflation, i.e. a "hyperdeflation." There always exist deficits so large that stationary solutions do not exist. Behavior then is unstable and explosive: hyperinflations are ruled out and hyperdeflations must result. Empirical studies of hyperinflations should no longer use the rational-expectations version of the Sargent-Wallace model as a theoretical backdrop. Copyright 1987 by Royal Economic Society.

Date: 1987
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