Understanding Inflation as a Joint Monetary–Fiscal Phenomenon

Abstract

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Optimal public debt composition during debt crises: A review of theoretical literature

“…-Shortening maturity due to incentive benefits can solve credibility problems and avoid inflationary costs and real exchange rate distortions associated with domestic currency debt (Korinek, 2011;Leeper & Leith, 2016;Ottonello & Perez, 2019).…”

“…In addition, lack of commitment to monetary policy raises additional costs because it leads to strong credibility or a time‐inconsistency problem, as investors perceive the optimal debt instruments (from the tax smoothing perspective) as creating incentives for causing inflationary surprises. Consequently, this increases inflationary expectations, especially at high public debt levels, and leads to higher compensatory borrowing costs that investors demand from sovereign borrowers (Leeper & Leith, 2016; Leeper et al., 2021).…”

“…Domestic currency debt plays a hedging or insurance role through movements in inflation or real exchange rates, while foreign currency debt exposes the sovereign to exchange rate risk and increases the sovereign's vulnerability to financial or debt crises. However, foreign currency debt, which is denominated in a unit that is not controlled by the borrowing government, can solve credibility problems and avoid inflationary costs and real exchange rate distortions associated with domestic currency debt (Korinek, 2011; Leeper & Leith, 2016; Ottonello & Perez, 2019).…”

Public Debt and Household Inflation Expectations

“…Second, understanding the effects of public debt on inflation expectations is important well beyond the current economic conjuncture. The influence of public debt on inflation expectations is indeed central to the contentious debate about the role of fiscal policy in the determination of the price level, as for example discussed in Leeper and Leith (2016) and Cochrane (2023).…”

The Credibility of Monetary Policy and Procyclical Fiscal Policy

“…Nevertheless, inflation rate, as the monetary policy objective, is not only a phenomenon of monetary policy but also fiscal policy (Leeper and Leith 2016), so issues on fiscal-monetary interaction are crucial in determining monetary policy effectiveness. Sargent and Wallace (1981) illustrated that, in the long run, the monetary authority could lose its effectiveness to control the inflation rate when the monetary authority is assigned to accommodate the expenditure of the fiscal authority.…”