Inflation Expectations in Fiscal Policy Flashcards
What is debt monetization?
Debt monetization is when central banks finance deficits by increasing the money supply.
This process can lead to inflation expectations among the public and markets.
What risk arises when governments run persistent fiscal deficits?
The risk is that markets and the public may anticipate future inflation due to debt monetization.
This expectation can become self-fulfilling.
How can inflation expectations become self-fulfilling?
Businesses preemptively raise prices and workers demand higher wages to compensate for anticipated inflation.
This embeds inflationary pressures into the economy.
What historical example illustrates the effects of debt monetization?
The post-World War I Germany (Weimar Republic, 1921-1923) is a historical example.
The government financed its war debts by printing money.
What was the outcome of the German government’s decision to print money after World War I?
It led to hyperinflation, where the mark lost nearly all its value.
Prices doubled every few days at its peak.
What behavior did businesses and consumers exhibit during the hyperinflation in Germany?
They spent money rapidly, expecting continued devaluation.
This behavior exacerbated inflation.
How was the hyperinflation crisis in Germany resolved?
The crisis was resolved with the introduction of the Rentenmark in 1924, alongside fiscal stabilization and external assistance.
The Dawes Plan also played a role in stabilization.
What is the effect of austerity on inflation expectations?
Austerity can shift expectations towards lower inflation or deflation due to reduced government spending and lower aggregate demand.
Austerity includes measures such as spending cuts or tax hikes aimed at reducing deficits.
What happens to inflationary pressures when fiscal discipline is tightened?
Expectations of tighter fiscal discipline reduce inflationary pressures.
This can lead to lower aggregate demand as government spending decreases.
How can severe austerity affect business expectations?
Severe austerity can lead businesses to anticipate lower consumer demand, resulting in price cuts and reinforcing deflationary tendencies.
This reflects a cycle where reduced demand leads to further price reductions.
What historical event is cited as an example of austerity leading to deflation?
The Great Depression (1930s) is cited as an example where austerity measures worsened deflation and unemployment.
Governments under leaders like Hoover in the US and the National Government in the UK pursued austerity after the 1929 Wall Street Crash.
What was the recommendation of the UK’s May Report in 1931?
The UK’s May Report recommended severe spending cuts, which worsened deflation and unemployment.
This report was part of the austerity measures implemented during the Great Depression.
What actions did Hoover take in 1932 that impacted the recession?
Hoover implemented tax hikes and spending reductions that deepened the recession before the New Deal reversed these policies in 1933.
The New Deal aimed to stimulate the economy after the austerity measures.
What was the outcome of austerity measures during the Eurozone Crisis (2010s)?
Austerity measures led to prolonged deflationary pressures, slow growth, and high unemployment in countries like Greece, Spain, and Italy.
Particularly affected was southern Europe, which struggled with the impacts of these measures.
What influences short-term inflation expectations due to deficit spending?
Expectations of inflation can materialize in the short term due to deficit spending.
Short-term inflation is often driven by immediate financial policies and market reactions.
What is necessary for long-term inflation to occur in relation to deficits?
Long-term inflation depends on whether deficits are monetized.
Monetization refers to the process of converting deficits into money supply, which can lead to inflation.
What effect can austerity have on inflation expectations?
Austerity may lower inflation expectations but can also lead to stagnation, reducing long-term growth potential.
Stagnation refers to a prolonged period of slow economic growth.
How can market confidence affect debt sustainability?
If a government’s fiscal expansion is perceived as productive investment, inflation expectations may remain stable.
Productive investments include infrastructure and education that promote economic growth.
What can excessive austerity do to market confidence?
Excessive austerity can erode confidence if it weakens economic recovery.
This phenomenon was notably observed during Japan’s Lost Decade.
How does policy credibility relate to central bank independence?
If central banks are seen as independent and committed to inflation targeting, inflation expectations can be anchored despite fiscal deficits.
An example is the Bank of England’s inflation target of 2%.
What happens to inflation expectations if monetary policy is subordinated to fiscal needs?
Inflation expectations become destabilized.
This situation is often linked to hyperinflationary episodes.
