The research in this project aims to deepen our understanding of inflation by exploring the interaction between what central banks do, how people form expectations, and how both of these interact with financial markets and with the resource flows that come with them. The last twenty years in Europe (as well as the UK and the US) have seen inflation lower and more stable than ever before in recorded history. At the same time, three concerns have emerged. First, before the pandemic there was increasing concern that central banks had lost their ability to raise inflation, and especially that inflation expectations in financial markets have anchored at too low a level. In 2021-22 these concerns led to fears that inflation expectations had become unanchored, and that the central bank was powerless to stop the rise in inflation because of the self-fulfilling nature of these expectations. Second, with a large and growing public debt, and central banks that have large balance sheets with many government bonds in their assets, there is a realization of a growing tension between the actions of the central bank and their fiscal implications for the ministers of finance. Moreover, after the pandemic, the sharp rise in public debt coming hand in hand with the inflation of 2021-22 led to a reinvestigation of the old possibility of inflating away he public debt. Third, with the undertaking of many unconventional policies by central banks in response to the financial crises, choices must be made on which of these policies to keep in normal times or not.
This research answers these questions. It uses insights from finance and economic history, together with new methods, and unconventional approaches on the solvency of a central bank or the use of monetary policy tools, to understand what determines actual and expected inflation. It uses new data, and introduces new models, that can provide a deeper understanding of the dynamics of inflation. All of the questions above were answers making some progress in deepening our knowledge of inflation and of the interaction between central banks and financial markets. The importance of this is especially clear today, in 2022, as inflation looms large as one of the main problems according to surveys in many European countries.
