Fiscal Policy and Inflation Expectations

Theory suggests that inflation expectations play an important role in transmitting fiscal considerations into inflation. We contribute new empirical evidence of a positive relationship between the budget deficit to GDP and inflation expectations of firms. This suggests interdependence between fiscal and monetary policies, which may imply that monetary policy faces more challenges to maintain inflation expectation anchored when the fiscal outcomes worsen. The result is robust to considering other fiscal variables and to controlling for macroeconomic covariates.