In the aftermath of the COVID-19 pandemic, advanced economies experienced significant increases in government debt and inflation. US government debt rose from 100 percent to 124 percent of GDP within a year, while inflation exceeded prepandemic central bank targets. Despite the increase in debt, few governments raise revenue collections. This paper analyzes the interaction between monetary policy and government debt in a New Keynesian model. It shows that monetary authorities can alleviate debt pressure. By applying the model to U.S. data, the paper provides insight into inflation overshoot following the pandemic. The findings highlight the critical role of accommodating monetary policy in managing inflation and debt dynamics, particularly when tax policy is slow to respond.
Understanding a timely path of inflation in high-debt economies
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