I was happy to read this study that recognizes that there can be fiscal drivers of inflation, and that fiscal discipline needs to be part of any efforts to control it. The authors are economists at the Chicago Fed and Johns Hopkins University, and it is published by the Kansas City Federal Reserve:
Here is a snippet:
Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.
The authors warn that failure to address fiscal drivers of inflation will result in stagflation:
When fiscal imbalances are large and fiscal credibility wanes, it may become increasingly harder for the monetary authority to stabilize inflation around its desired target. If the monetary authority increases rates in response to high inflation, the economy enters a recession, which increases the debt-to-GDP ratio. If the monetary tightening is not supported by the expectation of appropriate fiscal adjustments, the deterioration of fiscal imbalances leads to even higher inflationary pressure. As a result, a vicious circle of rising nominal interest rates, rising inflation, economic stagnation, and increasing debt would arise.
The study concludes:
Following the COVID pandemic, the United States, like many other countries, has implemented robust fiscal interventions. We have shown that these policy interventions facilitated the quick rebound observed after the pandemic recession. At the same time, they also contributed to the surge in fiscal inflation. Increasing rates, by itself, would not have prevented the recent surge in inflation, given that large part of the increase was due to a change in the perceived policy mix. In fact, increasing rates without the appropriate fiscal backing could result in fiscal stagflation. Instead, conquering the post-pandemic inflation requires mutually consistent monetary and fiscal policies providing a clear path for both the desired inflation rate and debt sustainability.
The excitement of seeing this study that recognizes the connection between fiscal and monetary policy is tempered by the behavior of the Biden administration and this Congress (aided at times by Republicans, such as in the case of the CHIPS Act) who not only failed to consider implementing fiscal consolidation to go along with the Fed’s rate hikes but continue to spend like drunken sailors.
Jack Salmon and I wrote about the need for a fiscal discipline to help the Fed here, here, and many other places since 2021.
I will also point to this important paper by UVA economist Eric Leeper presented last year at the Jackson Hole conference and recommend reading everything by Stanford economist John Cochrane.