We develop a theoretical framework to account for the observed instability of the link between inflation and fiscal … bank that has full control over inflation. When policy makers deviate from this Virtuous regime, agents conduct Bayesian … pessimistic about a prompt return to the Virtuous regime and inflation starts drifting in response to a fiscal imbalance. Shocks …

We analyse optimal monetary and fiscal policy in a New-Keynesian model with public debt and inflation persistence … requires debt to be returned to its pre-shock level. This finding has two important implications for optimal discretionary … the interest rate in response to a cost-push shock - and therefore violates the Taylor principle. We show that this …