RT @QJEHarvard: #QJE Aug 2025, #6, “A Monetary-Fiscal Theory of Sudden Inflations,” by Bassetto and Miller (@dsmintex): .

The paper is a warning: the lack of connection between government debt and deficits and inflation may not continue forever, and when the connection comes, the results are sudden.

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There’s even a region of multiple equilibria. You can’t judge whether debt is informationally sensitive or not based only on the fundamentals.

The information aspect adds additional possible outcomes. There can be inflation scares, where people make the effort, and trigger an inflation that induces the fiscal and/or monetary authority to be better in the future (as in End of Four Big Inflations).

But why make the effort yourself if you can free ride off others’ effort? Prices reveal information after all. We design a model where information is complementary: everyone acts together because the loss from deviating is too great.

Once people make the effort, they become sensitive to prospective fiscal news. If they learn that deficits will be high in the future, they react quickly, suddenly pushing up inflation today. Transitioning from informationally insensitive to sensitive debt marks the danger zone.

We argue the connection usually doesn’t exist as people have little idea about the future surpluses that back nominal government debt, because it’s very hard to understand those surpluses. It’s only when they’re sufficiently worried that they’ll devote the effort to understand.

Why doesn’t news about government debt and deficits usually matter much for inflation? If you look at the data in advanced countries, there’s very little connection, yet models such as the FTPL imply there should be one.

RT @BYCTOM:

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