Abstract: We employ a model that allows for unfunded fiscal shocks to study inflation and real activity in the United Kingdom. Unfunded fiscal shocks are not backed by future fiscal adjustments and are instead stabilized with inflation. In an estimated quantitative model, we find that fiscal inflation was high in the 1960s and 1970s, but came down in the early 1980s. Following the pandemic, fiscal inflation has risen steadily due to rapidly growing government spending, which has contributed to greater persistence in inflation. Monetary and fiscal policy coordination has been instrumental in achieving both a soft landing and bringing inflation to target for the UK economy in the post-pandemic period.

Abstract: I investigate the impact of policy communications on agents’ real-time perceptions of fiscal inflation by integrating a high-frequency structural event study into a two-agent New Keynesian model with partially unfunded debt. I find that key monetary and fiscal events during the Great Recession were associated with significant changes in expectation measures, which translated into sizable revisions in nowcasts of fiscal inflation and unfunded fiscal shocks, within a short time window around these events. The results reveal that the interplay between fiscal actions and central bank announcements plays a crucial role in shaping perceptions of debt stabilization and related fiscal inflation.

Draft available upon request