On the Low-Frequency Relationship Between Public Deficits and Inflation

Abstract

We estimate the low-frequency relationship between public deficits and inflation and study how it has evolved over time. Using a multivariate unobserved components model for the United States, the United Kingdom, and Germany, we decompose inflation and fiscal variables into trend and cycle and allow the long-run link between deficits and inflation to vary across regimes. The estimation results show that a positive long-run association between fiscal deficits and inflation is present in some periods, especially when fiscal policy is dominant and monetary policy does not fully stabilize prices. In contrast, under monetary dominance the low-frequency co-movement largely weakens. These findings highlight the importance of the institutional framework governing monetary–fiscal interactions for understanding episodes in which “fiscal inflation” emerges.

Citation

Kliem, Martin, Alexander Kriwoluzky, and Samad Sarferaz (2016). “On the Low-Frequency Relationship Between Public Deficits and Inflation.” Journal of Applied Econometrics 31(3): 566–583. [web:336][web:341]

@article{KKS2016a,
author = {Kliem, Martin and Kriwoluzky, Alexander and Sarferaz, Samad},
title = {On the Low-Frequency Relationship Between Public Deficits and Inflation},
journal = {Journal of Applied Econometrics},
volume = {31},
number = {3},
pages = {566-583},
doi = {https://doi.org/10.1002/jae.2427},
year = {2016}
}