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Debt, Inflation and Central Bank Independence
Making the central bank more independent from political pressures lowers inflation and increases the primary deficit, persistently. In the long-run, however, fiscal considerations are paramount and inflation comes back up to accommodate the higher financial burden of accumulated public debt. Endowing instead the central bank with an explicit inflation target lowers long-run inflation and implies non-trivial welfare gains for private agents. Inflation-targeting has the added virtue of determining the primary deficit independently of political frictions. The theory helps explain several key developments in postwar U.S. policy.
