Fiscal Influences on Inflation in OECD Countries, 2020-2022
The fiscal theory of the price level (FTPL) has been active for 30 years, and the interest in this theory grew with the recent global surges in inflation and government spending. This study applies the FTPL to 37 OECD countries for 2020-2022. The theory’s centerpiece is the government’s intertemporal budget constraint, which relates a country’s inflation rate in 2020 2022 (relative to a baseline rate) to a composite government-spending variable. This variable equals the cumulative increase in the ratio of government expenditure to GDP from 2020 to 2022, divided by the ratio of public debt to GDP in 2019 and the duration of the debt in 2019. This specification has substantial explanatory power for recent inflation rates across 20 non-Euro-zone countries and an aggregate of 17 Euro-zone countries. The estimated coefficients of the composite spending variable are significantly positive, implying that 40-50% of effective government financing came from the inverse effect of unexpected inflation on the real value of public debt, whereas 50 60% reflected conventional public finance (increases in current or future taxes or cuts in future spending). Within the Euro area, inflation reacts mostly to the area-wide government-spending variable, not to individual values.
We have benefited from comments and assistance with data by Laura Alfaro, Marco Bassetto, Gabriel Chodorow-Reich, John Cochrane, David Laibson, Eric Leeper, David Miller, Jon Steinsson, and Philip Stokoe, and from research assistance by Qingyuan Fang and Victoriah Verna. We also benefited from discussion at a seminar at Harvard University. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.