Household Beliefs about Fiscal Dominance

Andrade, Philippe; Gautier, Erwan; Mengus, Eric; Moench, Emanuel

doi:10.29412/res.wp.2025.02

Working Paper

Household Beliefs about Fiscal Dominance

Abstract: We study beliefs about fiscal dominance using a survey of German households. We first design and conduct a randomized controlled trial to identify how fiscal news impacts individuals’ debt-to-GDP and inflation expectations. We document that the link between debt and inflation crucially depends on individuals’ views about the fiscal space. News leading individuals to expect a higher debt-to-GDP ratio makes them more likely to revise their inflation expectations upward. These average effects are driven by individuals who think that fiscal resources are stretched. By contrast, individuals who think there is fiscal space do not associate debt with inflation. We then introduce a New Keynesian model in which agents have heterogeneous beliefs about the fiscal space. We show that such a heterogeneity of beliefs implies a policy tradeoff for the central bank: Agents who expect fiscal dominance in the future exert upward pressure on inflation, which the central bank should partially tolerate due to the real costs of completely stabilizing prices.

JEL Classification: E31; E52; H60; D84;

https://doi.org/10.29412/res.wp.2025.02