Inflationary Consequences of Anticipated Macroeconomic Policies

Abstract

Budget deficits implying an unbounded present value of government debt are infeasible and hence induce expectations of a future policy change. We study how expectations of a policy switch whose timing or mix between expenditure cuts, tax increases or increases in money growth rates may be uncertain, affect economic dynamics before the switch takes place. We are especially concerned with the correlation between changes in the deficit and inflation. Of particular interest is our finding that timing uncertainty may induce fluctuations in the rate of inflation that seem to be unrelated to the budget deficit, at a time when the budget deficit is responsible for inflation.

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