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Prepared by Xin Li, Kazuaki Miyachi and Niklas Westelius. A forthcoming IMF Working Paper will elaborate further on the details of staff’s assessment of the Fiscal Theory of Price Level (FTPL) and the simulations.
For a description of Japan’s experience with deflation see Box 3.2 in Chapter 3, World Economic Outlook, October 2016. Liu and Westelius (2016) and Anderson et al (2014) provide some evidence on the link between demographics and inflation.
Sims argues that, in Japan, this could be done by committing to a schedule of consumption tax increases conditional on meeting the inflation target (Sims, 2017).
It is also helpful to clarify some common misunderstandings about the FTPL. First, the FTPL is not a revival of traditional Keynesian theory, as it abstracts away from the fiscal multiplier effect. Second, the FTPL per se has nothing to do with debt monetization.
While a positive probability of default does not necessarily eliminate the transmission channel, it is not clear how inflation would respond in such a case due to the endogenous nature of the interest rate risk premium.
The OccBin toolkit for occasionally binding constraints is used to solve our model with the ZLB on nominal interest rate. See Luca Guerrieri and Matteo Iacoviello (2015).
IMF Working Paper, WP/13/87, GPM6 - The Global Projection Model with 6 Regions.
Negative realizations of a larger shock or higher autocorrelation imply a longer duration at the zero bound.