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A Monetary-Fiscal Theory of Sudden Inflations and Currency Crises

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Abstract

Treating nominal government bonds like other bonds leads to a new theory of sudden inflations and currency crises. Holmstrom (2015) and Gorton (2017) describe bonds as having costly-to-investigate opaque backing that consumers believe is sufficient for repayment. Government bonds' nominal return is their face value, their real return is determined by the government's surplus. In normal times, consumers are confident of repayment but ignorant of the true surpluses that will fund that repayment. When consumers' belief in real repayment wavers, they investigate surpluses. If consumers learn surpluses will be insufficient to repay bonds in real terms, the price level jumps. This explains why we observe inflationary crises, but never deflationary.

Suggested Citation

  • David S. Miller, 2021. "A Monetary-Fiscal Theory of Sudden Inflations and Currency Crises," Finance and Economics Discussion Series 2021-057, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2021-57
    DOI: 10.17016/FEDS.2021.057
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    References listed on IDEAS

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    More about this item

    Keywords

    Currency Crises; Price Level Determination; Monetary Fiscal Interaction; Fiscal Theory of the Price Level;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

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