Date: 2022
Type: Working Paper
Gambling to preserve price (and fiscal) stability
Working Paper, EUI RSC, 2022/72, Pierre Werner Chair Programme on Monetary Union
CORSETTI, Giancarlo, MAĆKOWIAK, Bartosz, Gambling to preserve price (and fiscal) stability, EUI RSC, 2022/72, Pierre Werner Chair Programme on Monetary Union - https://hdl.handle.net/1814/75056
Retrieved from Cadmus, EUI Research Repository
We study a model in which policy aims at aggregate price stability. A fiscal imbalance materializes that, if uncorrected, must cause inflation, but the imbalance may get corrected in the future with some probability. By maintaining price stability in the near term, monetary policy can buy time for a correction to take place. The policy gamble may succeed, with price stability preserved indefinitely, or fail, leading to a delayed, possibly large jump in the price level. The resulting dynamics resemble the models of a currency crisis following Krugman (1979) and Obstfeld (1986). Like in Obstfeld’s work, multiple equilibria arise naturally: whether or not price stability is preserved may depend on private agents’ expectations. The model can be reinterpreted as a model of partial default on public debt, in which case it is reminiscent of Calvo (1988).
Cadmus permanent link: https://hdl.handle.net/1814/75056
ISSN: 1028-3625
Series/Number: EUI RSC; 2022/72; Pierre Werner Chair Programme on Monetary Union
Publisher: European University Institute