A Monetary-Fiscal Theory of Sudden Inflations

Abstract: This paper posits an information channel as the explanation for sudden inflations. Consumers saving via nominal government bonds face a choice whether to acquire costly information about future government surpluses. They trade off the cost of acquiring information about the surpluses that back bond repayment against the benefit of a more informed saving decision. Through the information channel, small changes in the economic environment can trigger large responses in consumers' behavior and prices. This setting explains why there can be long stretches of time during which government surpluses have large movements with little inflation response; yet, at some point, something snaps, and a sudden inflation takes off that is strongly responsive to incoming fiscal news.

Keywords: Fiscal theory of the price level; Sudden inflation; Monetary fiscal interaction; Price level determination;

JEL Classification: E51; E31; E63; E52;

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Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2022-12-16

Number: 641