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Deficits and Inflation: HANK meets FTPL

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  • George-Marios Angeletos
  • Chen Lian
  • Christian K. Wolf

Abstract

In HANK models, fiscal deficits drive aggregate demand and thus inflation because households are non-Ricardian; in the Fiscal Theory of the Price Level (FTPL), they instead do so via equilibrium selection. Because of this difference, the mapping from deficits to inflation in HANK is robust to active monetary policy and free of the controversies surrounding the FTPL. Despite this difference, a benchmark HANK model with sufficiently slow fiscal adjustment predicts just as much inflation as the FTPL. This is true even in the simplest FTPL scenario, in which deficits are financed entirely by inflation and debt erosion. In practice, however, unfunded deficits are likely to trigger a persistent boom in real economic activity and thus the tax base, substituting for debt erosion. In our quantitative explorations, this reduces the inflationary effects of unfunded deficits by about half relative to that simple FTPL arithmetic.

Suggested Citation

  • George-Marios Angeletos & Chen Lian & Christian K. Wolf, 2024. "Deficits and Inflation: HANK meets FTPL," NBER Working Papers 33102, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:33102
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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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