Gambling to Preserve Price (and Fiscal) Stability

Giancarlo Corsetti and Bartosz Maćkowiak

No 17588, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study a model in which policy aims at aggregate price stability. A fiscal imbalance materializes that, if uncorrected, must cause inflation, but the imbalance may get corrected in the future with some probability. By maintaining price stability in the near term, monetary policy can buy time for a correction to take place. The policy gamble may succeed, preserving price and fiscal stability, or fail, leading to a delayed, possibly large jump in the price level. The resulting dynamics resemble the models of a currency crisis following Krugman (1979) and Obstfeld (1986). Like in Obstfeld’s work, multiple equilibria arise naturally: whether or not price stability is preserved may depend on private agents’ expectations. The model can be reinterpreted as a model of partial default on public debt, in which case it is reminiscent of Calvo (1988).

Keywords: Multiple equilibria; Self-fulfilling beliefs; Fiscal theory of the price level; Inflation expectations; Currency crisis (search for similar items in EconPapers)
JEL-codes: E31 F31 F41 (search for similar items in EconPapers)
Date: 2022-10
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Journal Article: Gambling to Preserve Price (and Fiscal) Stability (2024)
Working Paper: Gambling to preserve price (and fiscal) stability (2023)
Working Paper: Gambling to Preserve Price (and Fiscal) Stability (2023)
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