Active or Passive? Revisiting the Role of Fiscal Policy during High Inflation

Abstract

We investigate the interplay of the monetary–fiscal policy mix during times of crisis by drawing insights from the Great Inflation of the 1960s and 1970s. We use a Sequential Monte Carlo (SMC) algorithm to estimate a DSGE model with three distinct monetary/fiscal policy regimes. We show that, in such a model, SMC outperforms standard sampling algorithms because it is better suited to deal with multimodal posteriors, an outcome that is highly likely in a DSGE model with monetary–fiscal policy interactions. From the estimation with SMC, a differentiated perspective results: pre-Volcker macroeconomic dynamics were similarly driven by passive monetary/passive fiscal policy and fiscal dominance. We apply these insights to study the post-pandemic inflation period.

Citation

Ettmeier, Stephanie, and Alexander Kriwoluzky. 2024. “Active or Passive? Revisiting the Role of Fiscal Policy during High Inflation.” European Economic Review 170: 104874.

@article{EK24,
author = {Stephanie Ettmeier and Alexander Kriwoluzky},
year = {2024},
title = {Active or Passive? {R}evisiting the Role of Fiscal Policy during High Inflation},
journal = {European Economic Review},
volume = {170},
pages = {104874}}```