Price Level and Inflation Dynamics in Heterogeneous Agent Economies

Department of Economics and Decision Sciences
Speaker : Gianluca Violante (Princeton)
Room T-006

Abstract :

We study price level dynamics in a heterogeneous-agent incomplete-market economy with nominal government debt and flexible prices. Unlike in representative
agent economies, steady-state equilibria exist when the government runs persistent deficits, provided the level of deficits is not too large. We quantify the maximum sustainable deficit for the US and show that it is lower under more redistributive tax and transfer systems. With constant primary deficits, there exist two steady-states, and the price level and inflation are not uniquely determined. We describe alternative policy settings that deliver uniqueness. We conduct quantitative experiments to illustrate how redistribution and precautionary saving amplify price level increases in response to fiscal helicopter drops, deficit expansions, and loose monetary policy. We show that rising primary deficits can account for a decline in the long-run real interest rate, leading to permanently higher inflation. Our work highlights the role of household heterogeneity and market incompleteness in determining inflation dynamics. 

Joint work with : Giorgios Nikolakoudis (Princeton) & Greg Kaplan (Univ. of Chicago)