Lack of Trust and Fiscal Dominance: Evidence from a Firm Survey Experiment

We study how debt news shapes firms’ inflation expectations in a monetary union. In an active-control experiment, German firms receive optimistic or pessimistic projections of France, Italy, and Spain’s debt-to-GDP ratios. Pessimistic news raises debt beliefs and increases one- and three-year inflation expectations, with no detectable effect at five years. The response is driven by low-trust firms and by firms expecting relatively low ECB policy rates. A salient German debt-financed fiscal shock generates no comparable response. Within a Fisherian framework, the evidence suggests that debt news becomes inflationary when firms perceive incomplete fiscal backing and expect monetary accommodation.