Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/308391 
Year of Publication: 
2024
Series/Report no.: 
CESifo Working Paper No. 11495
Publisher: 
CESifo GmbH, Munich
Abstract: 
We append the expectation of a monetary-fiscal reform into a standard New Keynesian model. If a reform occurs, monetary policy will temporarily aid debt sustainability through a temporary burst in inflation. The anticipation of a possible reform links debt levels with inflation expectations. As a result, interest rates have two effects: they influence demand and affect expected inflation in opposite directions. The expectations effect is linked to the impact of interest rates on public debt. While lowering inflation in the short term is possible through demand control, inflation tends to rise again due to its impact on inflation expectations (sticky inflation). Optimal monetary policy may allow low real interest rates after fiscal shocks, temporarily breaking away from the Taylor principle. We assess whether the Federal Reserve's "staying behind the curve" was the right strategy during the recent post-pandemic inflation surge.
Subjects: 
monetary policy
monetary-fiscal coordination
inflation expectations
JEL: 
E31
E52
E63
Document Type: 
Working Paper
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