A key theoretical result 📜: optimal outcomes require the Fed to have significantly more bargaining power than the Treasury. Of course, a prerequisite for a strong central bank is an independent one. [5/12]
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This bargaining approach lets us quantify power dynamics that were previously difficult to measure. US fiscal power rose 📈 in the 60s and fell 📉 in the 80s, and spiked again 📈 after COVID. [6/12]
External validation 👍: The model's implied fiscal power closely tracks data on hours Presidents spent meeting with Fed officials 🤝 from Dreschel (2024)! Fortunately, power can be measured even after hours data end in 2008. [7/12]
Post-COVID fiscal bargaining power was 10x higher than post-GFC levels. This helps explain why we saw 6.2% inflation after COVID vs just 1.8% after GFC, despite large fiscal stimulus in both crises. [8/12]
The 1970s featured too much fiscal power ⬆️ compared to welfare-maximizing levels. Post-2008, fiscal power has been too low ⬇️ compared to first-best. Even the post-COVID inflation surge represented less-than-optimal inflation. Why? [9/12]
Key finding 🔑: Large government indebtedness makes surprise inflation a more effective financing tool, yet inflation harms households equally in both high- and low-debt economies. First-best fiscal power rises with government indebtedness. [10/12]
Broader lesson: Neither extreme is ideal - we want intermediate fiscal-monetary political power that aligns with economic conditions, including debt levels. Maintaining an independent central bank provides a way to achieve this outcome 👏👏 [11/12]
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