This paper estimates the causal effect of deficits on capital flows using the “multiplicative accounting method”. We identify the event that made the news about the 2021 deficit in the United States—the Georgia Senate election. We calculate the size of the shock using new narrative data from investment banks. We then study the high-frequency response of inflation forecasts to asset prices, to isolate the shortfall from other factors affecting inflation. We estimate an “inflation multiple” of 0.18% of inflation over two years, with a 1% deficit shock to GDP. Our estimate means that the 2021 deficit accounted for about 30% of 2021-22 inflation—meaning the deficit was important but not the only cause. The heterogeneous general agent New Keynesian model is similar in quantity and size to the inflation multiplier.
That appears in a new paper by Jonathon Hazell and Stepan Hobler.
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