Budget Deficits, Inflation Accounting, and Macroeconomic Policy: A Skeptical Note

Abstract

ABSTRACTThis paper challenges the mechanical application of inflation accounting to public sector deficits as it has been suggested in recent years. Although the theoretical considerations underlying the proposed adjustment for the inflation premium of interest payments are well taken, the new approach has fundamentally focused on measurement issues with little attention paid to the behavioral aspects of microeconomic adjustment. This paper, therefore, raises skepticism about the usefulness of inflation accounting, if such a correction is not accompanied by a conceptual model that links behavioral responses of individuals to balance sheets and other stock variables. In a departure from previous investigations, the paper also points out the possibility that inflation accounting might have more relevant implications for public, rather than private, spending.