## wpiea2023143-print-pdf

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---

### INTRODUCTION
- Key context and question
  - Between 2019 and 2022, in advanced economies, debt levels rose from 103.9 to 112.5 percent of GDP, and in emerging market economies, they grew from 55.1 to 64.6 percent of GDP.
  - Sovereign debt levels are expected to remain high in coming years, and higher levels of interest rates could increase debt services considerably.
  - Central question: Could the rise in government debt levels pose a problem for monetary policy, particularly through effects on inflation expectations and potential fiscal dominance?
- Main empirical finding (summary)
  - In response to debt surprises, inflation expectations in emerging market economies rise significantly, whereas they do not in advanced economies.
  - For emerging market economies, a 10-percentage-point increase in the government-debt-to-GDP ratio triggers:
    - a statistically significant 20-basis point increase in long-term inflation expectations within the first year after the shock, and
    - reaching a peak of 70-basis point within the second year.
  - The effect is much larger in emerging market economies that do not feature inflation targeting regimes compared to those that do.
  - The effect on inflation expectations is not present for emerging market economies with low sovereign debt levels.
- Implications highlighted
  - Results are consistent with mechanisms in which debt sustainability concerns (including fears of fiscal dominance or monetization) lead to disanchoring of long-term inflation expectations in vulnerable economies.
  - Findings align with prior evidence that fiscal tightening reduces inflation expectations in high-inflation and developing countries, but not in low-inflation advanced economies.

### THEORETICAL MECHANISMS
- Mechanisms linking government debt to price level and expectations
  - Fiscal dominance: a central bank tightens policy less in response to inflation when government debt is high, leading agents to raise inflation expectations.
  - If government debt is in local currency, high debt may lead central banks to limit policy-rate increases out of concern for government solvency; agents anticipate this and raise inflation expectations.
  - Extreme concerns include outright debt monetization, which would raise inflation expectations.
  - Fiscal Theory of the Price Level (FTPL): prices adjust so that the real value of government debt equals the present value of taxes less spending.
  - Bianchi and Melosi (2022): monetary–fiscal interaction becomes more acute when fiscal imbalances are large and fiscal credibility wanes.
  - Arellano and others (2020): sovereign default risk on external defaultable government debt affects inflation expectations via productivity–default channels.
- Nonlinearities emphasized
  - Higher sensitivity of inflation expectations to debt surprises in high-debt and high-inflation emerging market economies.
  - Distinction between advanced and emerging market economies is central due to differing histories of fiscal credibility, monetary frameworks, and vulnerabilities (e.g., currency mismatches).

### ECONOMETRIC APPROACH
- Identification strategy to address endogeneity
  - Use forecast errors from various vintages of IMF World Economic Outlook (WEO) publications to identify unanticipated exogenous shocks (surprises) to government debt.
  - Focus on long-run inflation expectations (5 years ahead) to minimize short-term aggregate demand effects.
  - Condition estimations on existing debt levels to further reduce influence of aggregate demand and simultaneity.
- Definition of debt shocks
  - debt_i,t_shock = Debt_i,t_realized / GDP_i,t-1_realized − Debt_i,t_forecast / GDP_i,t-1_realized
  - Debt shocks are the difference between realized annual growth rate of the debt-to-GDP ratio and the corresponding IMF forecast published in October.
- Robustness checks for forecastability
  - Regress debt forecast errors on forecast errors of inflation and real GDP growth and use residuals as debt shock.
  - Regress debt forecast errors on lagged macroeconomic variables—output gap, debt, and primary balance—and use residuals.
  - Country fixed effects included; results robust to alternative constructions.
- Estimation method
  - Panel regressions and local projections (Jordà (2005)) estimate responses of long-term inflation expectations to debt shocks over horizons.
  - Baseline specification includes country fixed effects (α_i^h), time fixed effects (ν_t^h), lags of debt shocks, vector of controls X_it′ (used in robustness checks).
  - Standard errors: Driscoll and Kraay (1998) heteroskedasticity and autocorrelation-consistent estimator.

### DATA
- Sample coverage
  - 41 emerging market and developing economies,
  - 7 low-income and developing countries,
  - 34 advanced economies,
  - covering the period between 2000 and 2020.
- Key variables and sources
  - Inflation expectations: survey-based inflation forecasts from professional forecasters reported by Consensus Economics for five years ahead, semi-annual frequency (April and October).
  - Government debt, GDP, output gap, and consumer price inflation: IMF World Economic Outlook (WEO) dataset (1995 to 2019 coverage for variables), forecasts from October WEO vintage and realized values from following year’s October WEO database.
  - Data cleaning follows Flores and others (2023).
- Summary statistics (Table 1)
  - Inf. Expectations, 5-yr:
    - Emerging mean: 3.91, s.d.: 1.92
    - Advanced mean: 2.04, s.d.: 0.44
    - Difference: 1.87*** (t = 17.92)
  - Debt Surprise:
    - Emerging mean: 0.65, s.d.: 4.49
    - Advanced mean: 0.59, s.d.: 4.14
    - Difference: 0.06 (t = 0.19)
  - Debt to GDP:
    - Emerging mean: 37.91, s.d.: 18.27
    - Advanced mean: 57.10, s.d.: 44.62
    - Difference: -19.19*** (t = -7.59)
  - CPI, y-o-y:
    - Emerging mean: 5.62, s.d.: 7.33
    - Advanced mean: 1.69, s.d.: 1.71
    - Difference: 3.93*** (t = 9.56)
  - Observations:
    - Emerging: 352
    - Advanced: 426
    - Total: 778

### RESULTS
- Main empirical results
  - Baseline finding: debt surprises raise long-term (5-year) inflation expectations in emerging market economies, but not in advanced economies.
  - Quantified effect for emerging markets:
    - 10-percentage-point increase in government-debt-to-GDP ratio ⇒
      - 20-basis point increase in long-term inflation expectations within the first year,
      - peak effect of 70-basis point within the second year.
  - Larger effects in emerging markets without inflation-targeting regimes; smaller effects where sound monetary frameworks and autonomous central banks are present.
- Heterogeneity and state dependence
  - Debt sustainability channel: effect absent for emerging markets with low sovereign debt levels.
  - Nonlinearities:
    - Higher sensitivity in high-debt and high-inflation emerging market economies.
  - Classification results:
    - Emerging markets with higher initial FX share of government debt and non-inflation-targeting regimes show stronger responses.

- Baseline regression coefficients (selected)
  - Full sample, Debt Surprise at horizons h = 4,10,16,22,28,34: 0.0042, 0.0114, 0.0237*, 0.0374*, 0.0262*, 0.0090
    - No. of Obs.: 778, 672, 671, 607, 606, 563
  - Emerging Market Economies, Debt Surprise at horizons h = 4,10,16,22,28,34: 0.0010, 0.0211**, 0.0447**, 0.0680**, 0.0484**, 0.0221*
    - No. of Obs.: 352, 280, 279, 252, 251, 232
  - Advanced Economies, Debt Surprise at horizons h = 4,10,16,22,28,34: 0.0042*, 0.0008, 0.0015, 0.0013, 0.0002, -0.0008
    - No. of Obs.: 426, 392, 392, 355, 355, 331
  - Notes: All regressions include lags of 5-year ahead inflation expectations, a 12-month lag of the debt shock, and country and time fixed effects. Driscoll-Kraay standard errors. * p < 0.10, ** p < 0.05, *** p < 0.01

### ROBUSTNESS
- Alternative shock constructions and controls
  - Filtering debt surprises on forecast errors of inflation and real GDP growth or on lagged macro predictors yields residual-based debt shocks; results remain similar.
  - Conditioning on existing debt levels reduces likelihood that results reflect short-term aggregate demand effects.
- State dependence: fiscal buffers, initial inflation, and currency composition
  - Debt level interaction (10th vs 90th percentiles):
    - Low debt group: impact statistically indistinguishable from zero.
    - High debt group: up to a 100-basis point increase in long-term inflation expectations after two years in response to a 10-percent surprise rise in debt-to-GDP.
  - Inflation level interaction:
    - For emerging markets at the 90th percentile of initial inflation: long-term inflation expectations increase by about 40 basis points after two years, rising to 50 basis points after three years following a 10-percent debt surprise.
    - For low initial inflation (10th percentile): impact statistically indistinguishable from zero.
    - Persistence: for high-inflation economies, expectations remain dislodged for at least three years.
  - Debt dollarization (FX debt share):
    - FX Debt Share coefficients significant and positive across horizons; interaction Debt Surprise # FX Debt Share becomes positive and significant after 22 months—vulnerability channel dominates.
    - Selected coefficients (Table 8): FX Debt Share: 0.0078***, 0.0105***, 0.0163***, 0.0168***, 0.0193***, 0.0202***; Debt Surprise # FX Debt Share: -0.0002, 0.0001, 0.0009, 0.0021***, 0.0017***, 0.0008**
- Role of monetary policy frameworks (inflation targeting)
  - Emerging market non-IT central banks show relatively higher sensitivity of long-term inflation expectations to a debt surprise than IT economies; differences not always statistically significant.
  - Suggestion: IT emerging market central banks better anchor medium-term expectations after fiscal shocks.
- Additional robustness checks
  - Controlling for fiscal stance (change in primary balance as percent of GDP and change in output gap) leaves results largely unchanged.
  - Using Financial Risk Rating (ICRG) as alternative debt-sustainability proxy: sensitivity of inflation expectations to debt surprises increases with ICRG risk measure (Table 9 interactions significant at horizons).
  - Alternative debt-shock constructions (residuals from regressions on forecast errors or lagged macro variables) yield qualitatively similar results; peak sensitivities slightly larger in some specifications.

### CONCLUSION
- Summary of approach
  - Assessed how unanticipated changes in government debt affect inflation expectations using WEO forecast errors and professional forecasters’ 5-year ahead inflation expectations.
- Main findings
  - Debt surprises raise long-term inflation expectations in emerging market economies.
  - Effects particularly strong when:
    - initial debt levels are already high;
    - inflation is already elevated;
    - monetary policy frameworks are weaker.
- Policy implications
  - In emerging market economies with high government debt levels, bringing debt to a sustainable path is likely important for containing inflation.
  - Adopting modern, forward-looking monetary policy frameworks such as inflation targeting can reduce inflationary concerns associated with government debt, creating more space for both monetary- and fiscal policy.
- Suggestions for further research
  - Quantify the degree to which debt concerns affect the inflationary process itself through the expectations channel.
  - Investigate the degree to which households’ and firms’ expectations are also influenced by government debt levels.

*Source: wpiea2023143-print-pdf*

### INTRODUCTION __________________________________________________________________________________ 5

### INTRODUCTION

### Key context and question
- Between 2019 and 2022, in advanced economies, debt levels rose from 103.9 to 112.5 percent of GDP, and in emerging market economies, they grew from 55.1 to 64.6 percent of GDP.
- Sovereign debt levels are expected to remain high in coming years, and higher levels of interest rates could increase debt services considerably.
- Central question: Could the rise in government debt levels pose a problem for monetary policy, particularly through effects on inflation expectations and potential fiscal dominance?

### Main empirical finding (summary)
- In response to debt surprises, inflation expectations in emerging market economies rise significantly, whereas they do not in advanced economies.
- For emerging market economies, a 10-percentage-point increase in the government-debt-to-GDP ratio triggers:
  - a statistically significant 20-basis point increase in long-term inflation expectations within the first year after the shock, and
  - reaching a peak of 70-basis point within the second year.
- The effect is much larger in emerging market economies that do not feature inflation targeting regimes compared to those that do.
- The effect on inflation expectations is not present for emerging market economies with low sovereign debt levels.

*This section summarizes the research motivation, approach, and headline empirical conclusions from the paper.*

### Implications highlighted
- Results are consistent with mechanisms in which debt sustainability concerns (including fears of fiscal dominance or monetization) lead to disanchoring of long-term inflation expectations in vulnerable economies.
- Findings align with prior evidence that fiscal tightening reduces inflation expectations in high-inflation and developing countries, but not in low-inflation advanced economies.

---

### THEORETICAL MECHANISMS

### Mechanisms linking government debt to price level and expectations
- Fiscal dominance: a central bank tightens policy less in response to inflation when government debt is high, leading agents to raise inflation expectations.
- If government debt is in local currency, high debt may lead central banks to limit policy-rate increases out of concern for government solvency; agents anticipate this and raise inflation expectations.
- Extreme concerns include outright debt monetization, which would raise inflation expectations.
- Fiscal Theory of the Price Level (FTPL): prices adjust so that the real value of government debt equals the present value of taxes less spending.
- Bianchi and Melosi (2022): monetary–fiscal interaction becomes more acute when fiscal imbalances are large and fiscal credibility wanes.
- Arellano and others (2020): sovereign default risk on external defaultable government debt affects inflation expectations via productivity–default channels.

### Nonlinearities emphasized
- The paper establishes nonlinearities: higher sensitivity of inflation expectations to debt surprises in high-debt and high-inflation emerging market economies.
- Distinction between advanced and emerging market economies is central due to differing histories of fiscal credibility, monetary frameworks, and vulnerabilities (e.g., currency mismatches).

---

### ECONOMETRIC APPROACH

### Identification strategy to address endogeneity
- Use forecast errors from various vintages of IMF World Economic Outlook (WEO) publications to identify unanticipated exogenous shocks (surprises) to government debt.
- Focus on long-run inflation expectations (5 years ahead) to minimize short-term aggregate demand effects.
- Condition estimations on existing debt levels to further reduce influence of aggregate demand and simultaneity.

### Definition of debt shocks
- Debt shock for country i at time t defined as:
  - debt_i,t_shock = Debt_i,t_realized / GDP_i,t-1_realized − Debt_i,t_forecast / GDP_i,t-1_realized
  - where lowercase debt variables denote debt-to-GDP ratios.
- Debt shocks are the difference between realized annual growth rate of the debt-to-GDP ratio and the corresponding IMF forecast published in October.

### Robustness checks for forecastability
- Two alternative approaches to ensure debt forecast errors are not predictable:
  - Regress debt forecast errors on forecast errors of inflation and real GDP growth and use residuals as debt shock (as in October 2017 WEO and Magud and Pienknagura (2022)).
  - Regress debt forecast errors on lagged macroeconomic variables—output gap, debt, and primary balance—and use residuals (as in Auerbach and Gorodnichenko (2013)).
- Country fixed effects included in these regressions.
- Results are quantitatively and qualitatively robust to these alternative shock constructions.

### Estimation method
- Use panel regressions and the local projections method of Jordà (2005) to estimate responses of long-term inflation expectations to identified government debt shocks over different horizons.
- Baseline local-projections specification includes:
  - country fixed effects (α_i^h) and time fixed effects (ν_t^h),
  - lags of debt shocks to control for persistence,
  - vector of controls X_it′ (used in robustness checks),
  - standard errors from Driscoll and Kraay’s (1998) heteroskedasticity and autocorrelation-consistent estimator.
- Projection horizons include lags and leads corresponding to response horizons used in the analysis.

---

### DATA

### Sample coverage
- The sample includes:
  - 41 emerging market and developing economies,
  - 7 low-income and developing countries,
  - 34 advanced economies,
  - covering the period between 2000 and 2020.

### Key variables and sources
- Inflation expectations: survey-based inflation forecasts from professional forecasters reported by Consensus Economics for five years ahead, at a semi-annual frequency (April and October).
- Government debt, GDP, output gap, and consumer price inflation: IMF World Economic Outlook (WEO) dataset (1995 to 2019 coverage for variables), with forecasts taken from October WEO vintage of each year and realized values from the following year’s October WEO database.
- Data cleaning follows Flores and others (2023) to minimize measurement errors and inconsistencies across vintages.

### Summary statistics (from Table 1)
- Inf. Expectations, 5-yr:
  - Emerging mean: 3.91, s.d.: 1.92
  - Advanced mean: 2.04, s.d.: 0.44
  - Difference: 1.87*** (t = 17.92)
- Debt Surprise:
  - Emerging mean: 0.65, s.d.: 4.49
  - Advanced mean: 0.59, s.d.: 4.14
  - Difference: 0.06 (t = 0.19)
- Debt to GDP:
  - Emerging mean: 37.91, s.d.: 18.27
  - Advanced mean: 57.10, s.d.: 44.62
  - Difference: -19.19*** (t = -7.59)
- CPI, y-o-y:
  - Emerging mean: 5.62, s.d.: 7.33
  - Advanced mean: 1.69, s.d.: 1.71
  - Difference: 3.93*** (t = 9.56)
- Observations:
  - Emerging: 352
  - Advanced: 426
  - Total: 778

---

### RESULTS

### Main empirical results
- Baseline finding: debt surprises raise long-term (5-year) inflation expectations in emerging market economies, but not in advanced economies.
- Quantified effect for emerging markets:
  - 10-percentage-point increase in government-debt-to-GDP ratio ⇒
    - 20-basis point increase in long-term inflation expectations within the first year,
    - peak effect of 70-basis point within the second year.
- Larger effects in emerging markets without inflation-targeting regimes; smaller effects where sound monetary frameworks and autonomous central banks are present.

### Heterogeneity and state dependence
- Debt sustainability channel: effect absent for emerging markets with low sovereign debt levels.
- Nonlinearities:
  - Higher sensitivity of inflation expectations to debt surprises in high-debt and high-inflation emerging market economies.
- Classification results:
  - Differences across initial debt level classifications and initial inflation level classifications matter for the magnitude and timing of responses.
  - Emerging markets with higher initial FX share of government debt and non-inflation-targeting regimes show stronger responses.

---

### ROBUSTNESS

### Alternative shock constructions and controls
- Filtering debt surprises on forecast errors of inflation and real GDP growth or on lagged macroeconomic predictors yields residual-based debt shocks; results remain qualitatively and quantitatively similar.
- Conditioning on existing debt levels reduces likelihood that results reflect short-term aggregate demand effects.

### Additional checks referenced
- Inclusion of controls such as output gap, debt, primary balance lags in forecasting equations for debt surprises.
- Use of country and time fixed effects and Driscoll–Kraay standard errors to account for cross-country correlation and serial dependence.
- The local-projections framework accommodates nonlinear impulse responses and cross-country error correlations.

---

### CONCLUSION

- Unexpected increases in government debt (debt surprises) are associated with meaningful dislocations in long-run inflation expectations in emerging market economies, consistent with concerns about fiscal dominance and debt sustainability.
- Advanced economies do not exhibit the same sensitivity of 5-year inflation expectations to debt surprises in the sample and period studied.
- Inflation-targeting regimes and lower initial debt stocks attenuate the sensitivity of inflation expectations to debt surprises in emerging markets.
- These findings underscore the importance of fiscal credibility, sound monetary frameworks, and monitoring of sovereign debt dynamics to preserve inflation-anchoring, especially in emerging market contexts.

*IMF Working Paper — "Debt Surprises and Inflation Expectations" (INTRODUCTION and methodological overview).*

### Annex II presents results when we use three-year ahead inflation expectations. Our main conclusions are unaltered when

### wpiea2023143-print-pdf - Annex II presents results when we use three-year ahead inflation expectations. Our main conclusions are unaltered when

### Data availability and forecast errors
- Market-based measures and household and firm surveys of inflation expectations are not available for most economies in our sample.
- Mean IMF forecast error:
  - emerging market economies: 0.65
  - advanced economies: 0.59
  - these are not statistically different from each other.
- Forecast errors tend to become large and positive during recessions (example: global financial crisis).
- Figures referenced: Figure 1 (data availability), Figure 2 (debt-to-GDP shocks on impact), Figure 3 (debt surprises across WEO vintages).

### Main results: impact of debt surprises on inflation expectations
- Baseline specification: impact of a debt shock on inflation expectations for the following three years (5-year ahead inflation expectations response to a 10 percent surprise in the debt-to-GDP ratio).
- Full sample:
  - A surprise 10 percent increase in government debt to GDP leads to a significant increase in long-term inflation expectations after about two years.
- Heterogeneity by country group:
  - Advanced economies: response of inflation expectations to a debt shock is zero across all horizons.
  - Emerging market economies: an unanticipated 10 percent increase in the government debt-to-GDP ratio results in:
    - a statistically significant 20-basis point hike in long-term inflation expectations within the first year after the shock,
    - reaching a peak of 70-basis point within the second year.
- Dynamics:
  - Impact is delayed and builds over time (possible reasons: data/public finance lags, adaptive/ backward-looking expectations, signaling of future higher deficits).
- Baseline regression coefficients (Table 2, Full Sample; coefficients shown for debt surprise at horizons h = 4,10,16,22,28,34):
  - Debt Surprise: 0.0042, 0.0114, 0.0237*, 0.0374*, 0.0262*, 0.0090
  - No. of Obs.: 778, 672, 671, 607, 606, 563
  - Adjusted R sq.: 0.60, 0.32, 0.12, 0.05, 0.03, 0.03
  - Notes: All regressions include 2-month and 8-month lags of 5-year ahead inflation expectations, a 12-month lag of the debt shock, and country and time fixed effects. Driscoll-Kraay standard errors in parentheses. * p < 0.10, ** p < 0.05, *** p < 0.01
- Baseline regression coefficients (Table 3, Emerging Market Economies):
  - Debt Surprise: 0.0010, 0.0211**, 0.0447**, 0.0680**, 0.0484**, 0.0221*
  - No. of Obs.: 352, 280, 279, 252, 251, 232
  - Adjusted R sq.: 0.63, 0.40, 0.17, 0.12, 0.05, 0.03
- Baseline regression coefficients (Table 4, Advanced Economies):
  - Debt Surprise: 0.0042*, 0.0008, 0.0015, 0.0013, 0.0002, -0.0008
  - No. of Obs.: 426, 392, 392, 355, 355, 331
  - Adjusted R sq.: 0.32, 0.11, -0.05, -0.08, -0.10, -0.13

### State dependence: fiscal buffers, initial inflation, and currency composition
- Government debt level (interaction with initial debt-to-GDP):
  - Response differs for countries at the 10th vs 90th percentiles of initial government debt.
  - Low debt group: impact statistically indistinguishable from zero.
  - High debt group: up to a 100-basis point increase in long-term inflation expectations after two years in response to a 10-percent surprise rise in debt-to-GDP.
  - Interpretation: debt sustainability concerns and perceived limits on central bank ability to stabilize prices are stronger when initial debt is high.
- Table 5 (Emerging Market Economies, Debt Level interaction) coefficients summary:
  - Debt Surprise: 0.0334*, 0.0364, 0.0165, -0.0582, -0.0552, 0.0207
  - Debt to GDP: -0.0034, 0.0050, 0.0017, -0.0097, -0.0112, -0.0179***
  - Debt Surprise # Debt: -0.0006*, -0.0003, 0.0006, 0.0027**, 0.0022**, -0.0000
  - No. of Obs.: 333, 276, 275, 248, 247, 228
  - Adjusted R sq.: 0.65, 0.40, 0.19, 0.24, 0.11, 0.04
- Inflation level (interaction with initial CPI, y-o-y):
  - For emerging markets at the 90th percentile of initial inflation:
    - Long-term inflation expectations increase by about 40 basis points after two years, rising to 50 basis points after three years following a 10-percent debt surprise.
  - For low initial inflation (10th percentile): impact statistically indistinguishable from zero.
  - Table 7 (Emerging Market Economies, Inflation interaction) coefficients summary:
    - Debt Surprise: 0.0027, 0.0027, 0.0003, -0.0116, -0.0090, -0.0240
    - CPI, y-o-y: 0.0162*, 0.0429**, 0.0580**, 0.0320, 0.0358, 0.0151
    - Debt Surprise # Inflation: -0.0005, 0.0003, 0.0018**, 0.0045***, 0.0035***, 0.0076**
    - No. of Obs.: 334, 268, 267, 240, 239, 220
    - Adjusted R sq.: 0.68, 0.50, 0.39, 0.46, 0.31, 0.13
  - Persistence: For high-inflation economies, inflation expectations remain dislodged for at least three years; contrast with debt-level interaction where expectations return roughly after three years.
- Debt dollarization (foreign currency debt share, fxshare):
  - Two opposing channels:
    - Higher local-currency share: more direct monetization/inflation concerns → larger sensitivity.
    - Higher foreign-currency share: greater vulnerability to external shocks and depreciation → larger sensitivity.
  - Regression includes interactions among debt surprise, debt level, and fxshare.
  - Results: positive and statistically significant effect of interaction between foreign currency debt levels, debt levels, and debt surprises after 22 months—vulnerability channel dominates.
  - Table 8 (Emerging Market Economies, FX Debt Share) coefficients summary:
    - Debt Surprise: 0.0039, 0.0136, 0.0039, -0.0234, -0.0208, -0.0011
    - FX Debt Share: 0.0078***, 0.0105***, 0.0163***, 0.0168***, 0.0193***, 0.0202***
    - Debt Surprise # FX Debt Share: -0.0002, 0.0001, 0.0009, 0.0021***, 0.0017***, 0.0008**
    - No. of Obs.: 321, 261, 260, 236, 235, 217
    - Adjusted R sq.: 0.65, 0.43, 0.24, 0.26, 0.18, 0.07

### Role of monetary policy frameworks (inflation targeting)
- Emerging market economies:
  - Non-inflation-targeting (non-IT) central banks show relatively higher sensitivity of long-term inflation expectations to a debt surprise than IT economies, but differences are not statistically significant.
  - Impulse profile for non-IT economies matches delayed de-anchoring seen in baseline results.
  - Suggestion: IT emerging market central banks better anchor medium-term expectations after fiscal shocks.
- Advanced economies:
  - No clear distinction between IT and non-IT regimes; at the end of the projection horizon sensitivity appears greater for inflation-targeting advanced economy central banks.

### Robustness checks
- Controlling for fiscal stance:
  - Include change in primary balance as a percent of GDP and change in output gap.
  - Results remain quantitatively and qualitatively robust (Figure 9).
- Alternative proxy for debt sustainability:
  - Use Financial Risk Rating (FRR) of ICRG (inverse of risk rating so higher indicates higher risk).
  - Sensitivity of inflation expectations to debt surprises increases with ICRG risk measure.
  - Figure 10: response for 10th and 90th percentiles of ICRG FRR — after the first year, impact significantly higher for highest risk decile.
- Debt shock construction alternatives:
  - Regress debt forecast errors on forecast errors of inflation and real GDP growth and use residuals as debt shock — results qualitatively similar and peak sensitivities slightly larger.
  - Project debt forecast errors on lagged macro variables (Auerbach and Gorodnichenko approach) and use residuals — results remain quantitatively and qualitatively robust.
- Table 9 (Regression Results, by ICRG Financial Risk Rating, Emerging Market Economies) summary:
  - Debt Surprise: 0.0493, -0.0043, -0.1042, -0.2697***, -0.2357***, -0.0217
  - Financial Risk Rating: 13.1319, 22.8277, 23.5666, 18.5699, -4.7757, -39.6436
  - Debt Surprise # ICRG FRR: -1.7191, 0.8848, 5.2006**, 11.8482***, 9.9753***, 1.5808
  - No. of Obs.: 342, 280, 279, 252, 251, 232
  - Adjusted R sq.: 0.63, 0.40, 0.20, 0.28, 0.15, 0.03

*Source: wpiea2023143-print-pdf*

### Conclusion

### Conclusion

### Summary of approach
- Explored a new way to assess how concerns about government debt levels can affect inflation expectations, based on unanticipated changes in government debt.

### Main findings
- Debt surprises raise long-term inflation expectations in emerging market economies.
- The effect is particularly strong when:
  - initial debt levels are already high;
  - inflation is already elevated;
  - monetary policy frameworks are weaker.
- The study focused on professional forecasters’ expectations.

### Policy implications
- In emerging market economies with high government debt levels, bringing them to a sustainable path is likely to be important for containing inflation.
- This is particularly relevant at the current juncture, after a sharp rise indebtedness around the COVID-19 shock, and with inflationary pressures around the world having proven strong and persistent.
- In the medium term, adopting modern, forward-looking monetary policy frameworks such as inflation targeting can reduce inflationary concerns associated with government debt, creating more space for both monetary- and fiscal policy.

### Suggestions for further research
- Quantify the degree to which debt concerns affect the inflationary process itself through the expectations channel.
- Investigate the degree to which households’ and firms’ expectations are also influenced by government debt levels.

*Source: wpiea2023143-print-pdf - Conclusion*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023143-print-pdf.pdf_