This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper provides comprehensive empirical evidence that supports the predictions of Sargent and Wallace's (1981) "unpleasant monetarist arithmetic" that an increase in public debt is typically inflationary in countries with large public debt. Drawing on an extensive panel dataset, we find that the relationship holds strongly in indebted developing countries, weakly in other developing countries, but generally not in developed economies. These results are robust to the inclusion of other variables, corrections for endogeneity biases, and relaxation of common-slope restrictions and are invariant over sub-sample periods. We estimate a VAR to trace out the transmission channel and find the impulse responses consistent with the predictions of a forward-looking model of inflation. Wealth effects of public debt could also affect inflation, as posited by the fiscal theory of the price level, but we do not find supportive evidence. The results suggest that the risk of a debt-inflation trap is significant in highly indebted countries, and pure money-based stabilization is unlikely to be effective over the medium term. Our findings stress the importance of institutional and structural factors in the link between fiscal policy and inflation.

This paper provides comprehensive empirical evidence that supports the predictions of Sargent and Wallace's “unpleasant monetarist arithmetic” that an increase in public debt is typically inflationary in countries with large public debt. Drawing on an extensive panel data set, we find that the relationship holds strongly in indebted developing countries, weakly in other developing countries, and generally does not hold in developed economies. These results are robust to the inclusion of other variables, corrections for endogeneity biases, relaxation of common-slope restrictions, and are invariant over subsample periods. We estimate a vector autoregression to trace out the transmission channel and find the impulse responses consistent with the predictions of a forward-looking model of inflation. Wealth effects of public debt could also affect inflation, as posited by the fiscal theory of the price level, but we do not find supportive evidence. The results suggest that the risk of a debt-inflation trap is significant in highly indebted countries and pure money-based stabilization is unlikely to be effective over the medium term. Our findings stress the importance of institutional and structural factors in the link between fiscal policy and inflation. IMF Staff Papers (2009) 56, 476–515. doi:10.1057/imfsp.2008.26; published online 21 October 2008

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.Russia's regions are heavily exposed to regional income shocks because of an uneven distribution of natural resources and a Soviet legacy of heavily skewed regional specialization. Also, Russia has a limited mobility of labor and lacks fiscal instruments to deal with regional shocks. We assess how these features influence the magnitude and persistence of regional income shocks, through a panel vector autoregression, drawing on extensive and unique regional data covering last decade. We find that labor mobility associated with regional shocks is far lower than in the United States yet higher than in the EU-15, and that regional expenditures tend to expand in booms and contract in recessions. We discuss institutional factors behind these outcomes and policy implications. JEL Classification Numbers: C33, E62, H77, J61, P52

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An uneven distribution of natural resources and the Soviet legacy of artificial regional specialization expose Russia's regions to large income shocks. Using an unique regional dataset covering Russian regions between 1992 and 2003, we assess how these features influence the magnitude and persistence of regional income shocks. We propose a novel measure of regional exogenous shocks that we use to show that fiscal policy in Russia's regions has largely been pro-cyclical, exacerbating rather than moderating regional exogenous shocks.JEL classifications: C33, E62, H77, J61, P52.