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Working Papers
Debt, Inflation, And Government Reputation
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
Public Good Provision And Optimal Taxation in a Hidden Savings World
Abstract This paper studies the optimal design of tax policy and public good provision in an economy where individual income is unobservable, but formal financial transactions are observable. In this environment, agents choose how much of their income to save either in a taxed, observable bank account or in an untaxed, hidden account (their ``couch''). I show that informality and tax evasion arise endogenously as responses to the tax schedule, and I characterize the welfare-maximizing tax structure under these considerations. The optimal tax is concave and flat beyond a threshold: it deters evasion at the top, and induces agents to save in the formal sector without taxing away the benefits of doing so. The model suggests that the optimal policy is to rationalize and tolerate some level of informality among the lower-income households to sustain incentive compatibility for richer agents and prevent evasion. The results highlight a trade-off between redistribution and public goods provision in the presence of hidden savings and offer novel insights into tax design for economies with large informal sectors.
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.
Paper
Mexico's Recent Inflation History as a Result of Fiscal Deficits and its Expectations
Abstract I present a hidden Markov framework that allows me to estimate the historical relationship between fiscal policy, inflationary expectations, and observed inflation for Mexico's case during 1969 and 2016. Due to a data availability problem with the historical sequences about fiscal policy and inflation expectations, I replicate the model presented in Sargent (JPE, 2006), a paper that proposes a parsimonious theoretical framework that explains Mexico's recent inflation history as a function of an estimated sequence of these variables. Therefore, the main results of this paper can be seen as an accounting exercise in which I am decomposing inflation into two components (fiscal and expected driven inflation) that are not orthogonal. The estimation suggests that deficit levels above 5\% have lead to the several high inflation episodes this country has experienced. Additionally, the role of expectations has been crucial since a 1\% increase in them has lead to a 0.56 percentage points inflation rise, on average. As a way to validate the model's predictions, I contrast the sequences generated by the model with the available data and observe an acceptable fit. Finally, as a contribution of this work, considering the estimated historical relationship, I present several forecasts of the 2017-2021 inflation rate that are function of potential fiscal deficit paths. These forecasts suggest that, in order to maintain a controlled inflation during the upcoming years, the Fiscal Authority should produce a moderate fiscal deficit.\
Paper
Work in Progress
Persuasion, Credibility, and Central Bank Communication
Abstract This project studies central bank communication through the lens of Bayesian persuasion. A central bank with private information about economic conditions strategically designs its messages to influence private expectations and macroeconomic outcomes. The framework highlights how optimal communication balances persuasion, credibility, and future discipline, and how different disclosure regimes shape inflation expectations, policy effectiveness, and welfare. The project aims to provide tractable tools for thinking about forward guidance, selective disclosure, and strategic ambiguity in monetary policy.
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