Is It Time for Some Unpleasant Monetarist Arithmetic?

Andolfatto, David

doi:10.20955/r.103.315-32

Journal Article

Is It Time for Some Unpleasant Monetarist Arithmetic?

Abstract: Sargent and Wallace (1981) published "Some Unpleasant Monetarist Arithmetic" 40 years ago. Their central message was that a central bank may not have the power to determine the long-run rate of inflation without fiscal support. In a policy regime where the fiscal authority is non-Ricardian, an attempt on the part of the central bank to lower inflation may end up backfiring. I develop a structural model to illustrate this result through the use of a diagram. In addition, I use the model to explain how low inflation, low interest rates, and high primary budget deficits can coexist. I also use the model to explain why it is easier for a central bank to lower inflation than to raise it. I conclude with some recommendations for state-contingent monetary policy.

Keywords: interest rates; monetary policy; inflation; budget deficits;

JEL Classification: E4; E5; E6;

https://doi.org/10.20955/r.103.315-32