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Financing COVID-19 Deficits in Fiscally Dominant Economies: Is The Monetarist Arithmetic Unpleasant?

Author

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  • Uribe, Martin

    (Columbia University)

Abstract
The coronavirus pandemic of 2019-20 confronted fiscally dominant regimes around the world with the question of whether the large deficits caused by the health crisis should be monetized or financed by issuing debt. The unpleasant monetarist arithmetic of Sargent and Wallace (1981) states that in a fiscally dominant regime tighter money now can cause higher inflation in the future. In spite of the qualifier ‘unpleasant,’ this result is positive in nature, and, therefore, void of normative content. I analyze conditions under which it is optimal in a welfare sense for the central bank to delay inflation by issuing debt to finance part of the fiscal deficit. The analysis is conducted in the context of a model in which the aforementioned monetarist arithmetic holds, in the sense that if the government finds it optimal to delay inflation, it does so knowing that it would result in higher inflation in the future. The central result of the paper is that delaying inflation is optimal when the fiscal deficit is expected to decline over time.

Suggested Citation

  • Uribe, Martin, 2020. "Financing COVID-19 Deficits in Fiscally Dominant Economies: Is The Monetarist Arithmetic Unpleasant?," East Asian Economic Review, Korea Institute for International Economic Policy, vol. 24(4), pages 417-440, December.
    • Handle: RePEc:ris:eaerev:0386
    DOI: 10.11644/KIEP.EAER.2020.24.4.386
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    Cited by:

    1. Giancarlo Corsetti & Bartosz Maćkowiak, 2024. "Gambling to Preserve Price (and Fiscal) Stability," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 72(1), pages 32-57, March.
    2. Nicolás Oviedo, 2022. "Deficit fiscal y tipo de cambio fijo: racionalizando una combinación insostenible," Young Researchers Working Papers 3, Universidad de San Andres, Departamento de Economia, revised Oct 2022.
    3. Daniel DĂIANU & Alexie ALUPOAIEI & Matei KUBINSCHI, 2022. "Revisiting Limits and Pitfalls of QE in the Emerging Markets," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 5-25, April.

    More about this item

    Keywords

    Optimal Monetary Policy; Inflation Tax; Fiscal Deficits; Public Debt;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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