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

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  • Stephanie Ettmeier
  • Alexander Kriwoluzky

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.

Suggested Citation

  • Stephanie Ettmeier & Alexander Kriwoluzky, 2024. "Active or Passive? Revisiting the Role of Fiscal Policy During High Inflation," CRC TR 224 Discussion Paper Series crctr224_2024_565, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2024_565
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    References listed on IDEAS

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    1. Francesco Bianchi & Renato Faccini & Leonardo Melosi, 2020. "Monetary and Fiscal Policies in Times of Large Debt: Unity is Strength," Working Paper Series WP 2020-13, Federal Reserve Bank of Chicago.
    2. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
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    More about this item

    Keywords

    Bayesian Analysis; DSGE Models; Monetary-Fiscal Policy Interactions; Monte Carlo Methods;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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