Abstract
In this paper, an attempt is made to properly identify the link between deficits and the rate of inflation by using two alternate macroeconomic models—one based on adaptive expectations and the other on rational expectations—for a multilevel government system. It is assumed that unlike federal deficits, state deficits cannot be monetized. Nonetheless, the interaction between state and federal inflation is explicitly incorporated into the model. When expectations are formed adaptively, the model confirms the positive link between deficits and rate of inflation. However, with rational expectations, the model shows that inflation is, in part, explained by the forecast error. It is proposed that only empirical testing of the theoretical models would give credence to such conclusions.
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Abizadeh, S., Benarroch, M. & Yousefi, M. A multilevel government model of deficits and inflation. Atlantic Economic Journal 24, 118–130 (1996). https://doi.org/10.1007/BF02299002
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DOI: https://doi.org/10.1007/BF02299002