Abstract: Unexpected inflation devalues nominal government bonds. It must therefore correspond to a decline in expected future surpluses, or a rise in their discount rates, so that the real value of debt equals the present value of surpluses. I measure each component via a vector autoregression, in response to inflation, recession, surplus and discount rate shocks. Discount rates, rather than deficits, account for most inflation variation. Smooth inflation that slowly devalues outstanding long-term bonds is an important mechanism.
Read the paper: The Fiscal Roots of Inflation