FISCAL POLICY AND INFLATION: PONDERING THE IMPONDERABLES

Eric M. Leeper

An asset-pricing perspective reveals that inflation depends on current and expected monetary and fiscal policies. There are three ways to carry $1 today into the future: money, bonds, and real assets. That dollar’s purchasing power varies inversely with the price level. Expected money growth, tax rates, and government spending directly impinge on the expected rates of return of these assets, and determine the price level and the inflation rate. The paper considers a tax reduction that is financed by new government debt. It examines how alternative responses of current and future policies to the tax cut can imply very different outcomes for inflation.