Inflation Dynamics: The Role of Public Debt and Policy Regimes

Woong Yong Park, Jae Won Lee and Saroj Bhattarai

No 359, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: We investigate the roles of a time-varying inflation target and monetary and fiscal policy stances on the dynamics of inflation in a DSGE model. Under an active monetary and passive fiscal policy regime, inflation closely follows the path of the inflation target and a stronger reaction of monetary policy to inflation decreases the equilibrium response of inflation to non-policy shocks. In sharp contrast, under an active fiscal and passive monetary policy regime, inflation moves in an opposite direction from the inflation target and a stronger reaction of monetary policy to inflation increases the equilibrium response of inflation to non-policy shocks. Moreover, a weaker response of fiscal policy to debt decreases the response of inflation to non-policy shocks. These results are due to variation in the value of public debt that leads to wealth effects on households. Finally, under a passive monetary and passive fiscal policy regime, both monetary and fiscal policy stances affect inflation dynamics, but because of a role for self-fulfilling beliefs due to equilibrium indeterminacy, theory provides no clear answer on the overall behavior of inflation. We characterize these results analytically in a simple model and numerically in a richer quantitative model.

Date: 2013
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Related works:
Journal Article: Inflation dynamics: The role of public debt and policy regimes (2014)
Working Paper: Inflation Dynamics: The Role of Public Debt and Policy Regimes (2013)
Working Paper: Inflation dynamics: the role of public debt and policy regimes (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed013:359

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