Discussion paper
DP18887 The Monetary Financing of a Large Fiscal Shock
Motivated by the surge in debt levels through the pandemic crisis, we revisit the issue of the optimal financing of public debt. In contrast to existing results, we find that the optimal response of inflation to a large increase in public spending is a gradual, significant and long-lasting rise in inflation. Our conclusion is due to a different assumption on the source of nominal rigidities. While the literature has focused on sticky prices, of either the Calvo (1983) or Rotemberg (1982) type, we consider sticky plans as in the sticky information set up of Mankiw and Reis (2002). A crucial feature of our results is that a significant inflation response is desirable if the maturity of public debt is (realistically) long.
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