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Working Papers
Debt, Inflation, And Government Reputation
Job Market Paper
Abstract This paper develops a theoretical framework to explain the correlation between public debt and inflation through different episodes, focusing on the role of government reputation (defined as the public's belief in the government's commitment to low inflation) in shaping inflation expectations. I propose a dynamic game model with incomplete information where private agents (wage setters) and a consolidated government (a player taking fiscal and monetary policy decisions) interact over time. The government's type is private information, and wage setters learn the type of the government through the observed history of implemented policies. The government can be either prudent, prioritizing low inflation, or imprudent, favoring short-term output and debt gains through higher inflation. Wage setters form inflation expectations based on the government's debt trajectory and its perceived reputation. The model implies a monotonic relationship between inflation and reputation, in the sense that higher government reputation implies lower inflation. In addition, as the government's reputation increases, the incidence of the current debt state on inflation is reduced. Hence, when reputation is strong, a government can sustain low inflation even with high debt. I calibrate the model using data from four emerging markets (Mexico, Colombia, Guatemala, and Thailand), illustrating how government reputation influences inflation dynamics. The findings underscore the importance of maintaining low inflation as debt rises to build and preserve government credibility while also providing insights into the periods of high correlation between debt and inflation observed in these economies.
Paper Slides
Fiscal Policy and Inflation: Understanding the Role of Expectations in Mexico
With Bernabe Lopez-Martin and Daniel Samano
Inter-American Development Bank, Working Papers, 2018
Abstract We exploit a hidden Markov model where inflation is determined by government deficits financed through money creation and/or by destabilizing expectations dynamics (expectations can potentially divorce inflation from fundamentals). The baseline model, proposed by Sargent et al. (2009), is used to analyze the interaction between fiscal deficits, inflation expectations, and inflation in Mexico. The model is able to distinguish between causes and remedies of hyperinflation, such as persistent or transitory shocks to seigniorage-financed fiscal deficits, deanchoring of inflation expectations from fiscal fundamentals, and cosmetic (non-fundamental) monetary reforms. The behavior of monetized deficits provides an adequate account of high inflation episodes and stabilizations for the period 1969-1994. We then extend the model to analyze the possibility that fiscal policy can affect inflation expectations in a context of Central Bank independence, as is the case in Mexico after 1994. We find evidence that the exchange rate and sovereign interest rate spreads influence the evolution of aggregate prices.
Work in Progress
Public Good Provision And Optimal Taxation in a Hidden Income World
Abstract Since Mirrlees' seminal work in 1971, the literature on optimal taxation has extensively debated the progressivity of income taxes. While it might seem appealing to impose higher taxes on wealthier individuals, various frictions, such as incomplete information, can result in optimal tax policies that are not necessarily progressive. This paper introduces a new dimension to this discussion: the role of informality. Informality allows individuals to earn income while concealing it from tax authorities. Although informal jobs typically yield lower incomes, high tax rates can incentivize individuals to shift from formal employment, where income is observable and taxable, to informal employment. I propose a public good contribution framework to analyze this scenario, showing that in the absence of informality, the optimal tax schedule is progressive. However, when informality is an available option, the optimal tax structure becomes concave, with flat marginal taxes at higher income levels, to prevent wealthier individuals from evading taxes by transitioning to the informal sector.
Slides
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