Frank Smets, John Taylor, Annelise Anderson, Chris Ball, Francesco Bianchi, Michael Boskin, Ruxandra Boul, Doug Branch, Matthew Canzoneri, Pedro Carvalho, John Cochrane, Steven Davis, John Duca, Jared Franz, Lance Gilliland, Paul Gregory, Bob Hall, Eric Hanushek, Greg Hess, Robert Hetzel, Laurie Hodrick, Robert Hodrick, Nicholas Hope, Otmar Issing, Robert King, Evan Koenig, Don Koch, Noah Kwicklis, David Laidler, Ross Levine, Mickey Levy, Dennis Lockhart, Hung Ly Dai, Klaus Masuch, Roger Mertz, Ilian Mihov, Athanasios Orphanides, Radek Paluszynski, David Papell, Elena Pastorino, Flavio Rovida, Allison Schrager, Tom Stephenson, Jack Tatom, Kevin Warsh


Frank Smets, advisor in the Counsel to the Executive Board at the European Central Bank in Frankfurt, Germany, and part-time professor of economics at Ghent University in Belgium, discussed “Fiscal Backing, Inflation and US Business Cycles,” a paper with Raf Wouters (advisor in the Economics and Research Department of the National Bank of Belgium).

John Taylor, the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution, was the moderator.


Monetary and fiscal-led equilibria in New Keynesian models (Leeper, 1991) are extreme regimes. A realistic model of monetary and fiscal policy interaction should allow for intermediate regimes where fiscal policy generally commits to serve current debt by running future surpluses, but it may not take the full burden of fiscal adjustment, whereas monetary policy is geared towards stabilizing inflation, but it may have to face the inflationary consequences of partially unfunded government debt. Cochrane (2022) describes this as a regime of partial fiscal backing. This paper estimates an extended Smets and Wouters (2007) model for the US economy which allows for partial fiscal backing to answer three main questions. What has been the average degree of fiscal backing in the US economy? Are the most important drivers of inflation monetary or fiscal-led? How does partial fiscal backing affect the transmission of various business cycle shocks to economic activity and inflation? We find that on average 80 percent of the fiscal implications of business cycle shocks, including fiscal shocks, are funded. As a result, the drivers of inflation are mostly of a monetary nature, although there are episodes like the 1960s and 1970s when fiscal-led inflation is also relevant. Partial fiscal backing does affect the transmission of fiscal transfer and supply shocks to output and inflation, but not so much that of monetary policy or demand shocks. Finally, most of the post-pandemic rise and fall in inflation is explained by supply shocks. Expansionary fiscal policy contributed to higher inflation in 2021, mostly offsetting the disinflationary effects of negative demand developments following the outbreak of the pandemic.

To read the paper click here
To read the slides, click here


Topic: “Fiscal Backing, Inflation and US Business Cycles”
Start Time: April 3, 2024, 12:00 PM PT 

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