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The role of fiscal policy in Britain's Great Inflation

Fan, Jingwen, Minford, Anthony Patrick Leslie and Ou, Zhirong 2016. The role of fiscal policy in Britain's Great Inflation. Economic Modelling 58 , pp. 203-218. 10.1016/j.econmod.2016.05.027

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Abstract

We investigate whether the Fiscal Theory of the Price Level (FTPL) can explain UK inflation in the 1970s. We confront the identification problem involved by setting up the FTPL as a structural model for the episode and pitting it against an alternative Orthodox model; the models have a reduced form that is common in form but, because each model is over-identified, numerically distinct. We use indirect inference to test which model could be generating the VECM approximation to the reduced form that we estimate on the data for the episode. Neither model is rejected, though the FTPL model substantially outperforms the Orthodox. But by far the best account of the period assumes that expectations were a probability-weighted combination of the two regimes. Fiscal policy has a substantial role in this weighted model in determining inflation. A similar model accounts for the 1980s but this role of fiscal policy is much diminished.

Item Type: Article
Date Type: Publication
Status: Published
Schools: Business (Including Economics)
Subjects: H Social Sciences > HJ Public Finance
Publisher: Elsevier
ISSN: 0264-9993
Date of First Compliant Deposit: 14 June 2016
Date of Acceptance: 27 May 2016
Last Modified: 04 Jun 2017 09:12
URI: http://orca.cf.ac.uk/id/eprint/91842

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