Inflation Targeting under Fiscal Fragility

Aloisio Araujo, Vitor Costa, Paulo Lins, Rafael Santos and Serge de Valk

American Economic Journal: Macroeconomics, 2026, vol. 18, issue 2, 292-331

Abstract: We propose a model to study an inflation-targeting regime under a high government debt burden. We assume that an altruistic policymaker chooses debt issuance, inflation, and public expenditure, while private agents dislike inflation and finance the government. We show that equilibrium inflation depends on debt level: (i) on-target when debt is low; (ii) above the target when debt is high; (iii) either above or on-target in between, a zone that we named fiscal fragility. Equilibrium inflation also depends on the target level: A higher target may improve welfare by preventing fiscal fragility and reducing debt-rollover costs.

JEL-codes: E31 E52 E62 E63 H63 O11 O23 (search for similar items in EconPapers)
Date: 2026
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DOI: 10.1257/mac.20230291

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