Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/283401 
Year of Publication: 
2023
Series/Report no.: 
ECB Working Paper No. 2844
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
We study a model in which policy aims at aggregate price stability. A fiscal imbalance materializes that, if uncorrected, must cause inflation, but the imbalance may get corrected in the future with some probability. By maintaining price stability in the near term, monetary policy can buy time for a correction to take place. The policy gamble may succeed, preserving price and fiscal stability, or fail, leading to a delayed, possibly large jump in the price level. The resulting dynamics resemble the models of a currency crisis following Krugman (1979) and Obstfeld (1986). Like in Obstfeld's work, multiple equilibria arise naturally: whether or not price stability is preserved may depend on private agents' expectations. The model can be reinterpreted as a model of partial default on public debt, in which case it is reminiscent of Calvo (1988).
Subjects: 
multiple equilibria
self-fulfilling beliefs
fiscal theory of the price level
inflation expectations
currency crisis
sovereign default
JEL: 
E31
F31
F41
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-6189-9
Document Type: 
Working Paper

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