Bridging HANK and FTPL
Angeletos et al., in this paper, investigate how fiscal deficits drive inflation by bridging the Fiscal Theory of the Price Level (FTPL) and Heterogeneous Agent New Keynesian (HANK) models. They compare their mechanisms, robustness, and quantitative predictions, particularly in light of post-COVID inflationary dynamics.
Key methodological contributions:
- Theoretical framework
– FTPL: Assumes inflation arises from equilibrium selection when deficits are unbacked by future surpluses, requiring price jumps to stabilize debt. Controversial due to reliance on equilibrium assumptions.
– HANK: Incorporates household heterogeneity and liquidity constraints, where deficits stimulate demand via non-Ricardian behavior (e.g., short horizons or borrowing limits), bypassing equilibrium selection. - Equivalence result
Despite differing mechanisms, HANK can replicate FTPL’s inflation predictions under delayed fiscal adjustment (slow tax hikes). Both models predict similar inflation magnitudes if fiscal responses are sufficiently postponed. - Robustness analysis
– HANK avoids FTPL’s fragility to policy mix changes (e.g., active monetary/passive fiscal regimes) and refinements of long-term expectations.
– FTPL’s reliance on equilibrium selection makes it sensitive to theoretical critiques, while HANK’s demand-driven mechanism is empirically grounded. - Quantitative model
– Extends HANK with long-term debt and a hybrid Phillips curve (incorporating backward-looking inflation dynamics).
– Calibrated to match empirical intertemporal MPCs, debt maturity, and tax base feedback.
Findings:
- Inflation mechanisms
– FTPL: Inflation via equilibrium selection (prices jump to erode debt value).
– HANK: Inflation via demand boosts from non-Ricardian households spending deficits. - Equivalence under delayed fiscal adjustment
– With slow fiscal adjustment (e.g., delayed tax hikes), HANK matches FTPL’s inflation predictions. For example, a 1% GDP deficit induces identical price jumps in both models if tax adjustments are postponed indefinitely. - Dampening effects
– Tax base feedback (higher activity → higher taxes) and long-term debt reduce cumulative inflation by about 50% vs. FTPL’s “simple arithmetic” (full deficit financing via prices).
– Inflation front-loading in HANK (due to short household horizons) further moderates debt erosion. - Post-COVID Application
HANK predicts smaller, shorter-lived inflation than FTPL. For the 2020–2021 U.S. stimulus, cumulative inflation was about half of FTPL’s prediction, aligning better with observed data.
While FTPL and HANK align theoretically under delayed adjustment, HANK’s realistic mechanisms and quantitative discipline show deficits are less inflationary than FTPL suggests, offering a robust lens for policy analysis.
Deficits and Inflation: HANK meets FTPL
Authors: George-Marios Angeletos, Chen Lian, Christian K. Wolf
From: Northwestern University, UC Berkeley, MIT
Some empirical validation of FTPL’s inflation predictions
Barro and Bianchi, in this paper, test FTPL’s prediction that unfunded deficits trigger inflation via debt erosion. They quantify that 80% of post-pandemic OECD inflation was derived from unanticipated debt devaluation, aligning with Angeletos et al.’s conclusion that debt erosion dominates conventional fiscal adjustments. Both papers use debt-to-GDP dynamics to model inflationary pressures, though the Barro and Bianchi study focuses on cross-country regressions rather than HANK-FTPL microfoundations.
More specifically, Barro and Bianchi’s theoretical framework is based on Cochrane’s (2001) model of a frictionless economy without nominal rigidities. They define a “composite fiscal variable” that operationalizes the FTPL’s premise i.e. inflation emerges when fiscal trajectories imply that future surpluses cannot stabilize debt. The composite fiscal variable aggregates multiple interrelated fiscal indicators (increases in government spending relative to GDP, pre-existing debt-to-GDP ratios, and weighted maturity of government debt) into a unified measure that reflects the net fiscal pressure on an economy.
Data and empirical approach:
- Inflation metrics: Headline and core CPI inflation rates (2020–2023) from 37 OECD countries.
- Fiscal variables: IMF data on general government primary expenditure, debt-to-GDP ratios, and debt duration.
- Regression design: Cross-country analysis testing the composite variable’s explanatory power. Eurozone countries are aggregated to account for shared monetary policy.
- Controls: Proximity to the Ukraine-Russia war (border dummy) to isolate geopolitical inflationary effects.
- Debt composition: Adjusted for foreign currency-denominated and inflation-indexed debt using BIS data.
- Fiscal dominance assumption: Monetary policy is assumed to accommodate fiscal needs, consistent with COVID-era coordination.
Findings:
- Fiscal expansion drove inflation
– 80% of post-pandemic inflation stemmed from debt erosion via unanticipated inflation, while only 20% reflected conventional fiscal adjustments (tax hikes/spending cuts). This aligns with FTPL predictions that unfunded deficits trigger price-level jumps. - Eurozone specificity
Inflation responded to area-wide fiscal shocks rather than individual national policies, emphasizing the bloc’s integrated debt market. - Theoretical and practical contributions
– The mechanism operates strongly during extreme fiscal interventions (e.g., wars, pandemics), not in “normal” times.
– Barro and Bianchi confirm that even under FTPL-like mechanisms, real-world inflation depends on debt maturity and initial debt burdens, reinforcing Angeletos et al.’s emphasis on fiscal inertia.
Fiscal Influences on Inflation in OECD Countries, 2020-2023
Authors: Robert J. Barro, Francesco Bianchi
From: Harvard University, Johns Hopkins University
