Central bankers spend a lot of time reassuring the public that they will do whatever it takes to keep inflation in check. But what happens when firms don’t quite believe them? A new study suggests the answer matters a great deal, especially in a currency union where one central bank must reckon with the fiscal choices of many governments.
In an NBER working paper, economists Francesco Bianchi (Johns Hopkins University), Renato Faccini (Danmarks Nationalbank), Leonardo Melosi (European University Institute), and Nils Wehrhöfer (Bundesbank) examine how German firms react when they receive news about the debt trajectories of France, Italy, and Spain. The answer depends heavily on whether those firms trust the European Central Bank to hold the line on prices.
The question behind the experiment
Economists have long recognized that a central bank cannot single-handedly guarantee price stability if governments run up debts they cannot repay. At some point, the reasoning goes, fiscal pressure can force monetary authorities to tolerate higher inflation to ease the burden of that debt. This scenario has a name, “fiscal dominance,” and the euro area is a natural place to look for it, since a single central bank shares a currency with twenty national treasuries, some more disciplined than others.
The authors wanted to know whether firms actually think this way. Do businesses treat sovereign debt news from fiscally shaky member states as inflationary? And does the answer depend on how much they trust the ECB in the first place?
Designing the survey experiment
To find out, the researchers embedded a randomized experiment inside the Bundesbank Online Panel of Firms, a quarterly survey representative of German businesses. Roughly 7,000 firms participated in the first quarter of 2024. About 90% of respondents were owners, executive directors, or board members, meaning the people answering were also the people setting prices and making investment calls.
Firms were randomly assigned to receive one of two scenarios about the average debt-to-GDP ratio of France, Italy, and Spain over the coming five years, drawn from projections published by the European Commission. The optimistic scenario projected a decline from 123% to 105% of GDP. The pessimistic scenario projected an increase to 140%. Both figures came from the Commission’s own sustainability report, lending realism to each version.
After receiving one of the two projections, firms were asked about their expectations for future debt levels, German inflation at one-, three-, and five-year horizons, GDP growth, their own prices and wages, and their perceived likelihood of various euro-area scenarios including a sovereign debt crisis and fiscal dominance itself.
The design has a specific virtue: because the news concerned foreign debt, revisions in German firms’ inflation expectations could not easily be explained by direct effects on German taxes or spending. That leaves beliefs about how the ECB might respond as the main plausible channel.
What the responses revealed
The pessimistic projection shifted beliefs noticeably. Firms that received it raised their expected debt-to-GDP ratio for the three countries by about 17 percentage points relative to those in the optimistic group. That amounts to a “learning rate” of roughly 48% of the gap between the two scenarios, a sizable adjustment given that firms presumably had some prior view already.
More striking were the effects on inflation expectations. Firms exposed to the pessimistic news raised their one-year inflation expectations by about 0.17 percentage points and their three-year expectations by about 0.42 percentage points. Five-year expectations did not budge in any statistically detectable way.
That pattern, elevated in the short and medium term but anchored in the long run, is what the authors argue distinguishes a monetary regime under strain from one that has fully lost credibility. Firms appear to believe that inflation will run above target for several years, but not permanently.
Trust as the dividing line
The researchers had access to an earlier survey question asking firms, on a 0-to-10 scale, how much they trusted the ECB to deliver price stability. About 44% of German firms reported low trust. And those firms were substantially more likely to view a fiscal-dominance scenario as plausible: moving from the highest to the lowest trust bucket raised the share of firms who considered fiscal dominance likely from around 40% to about 70%.
Splitting the sample by trust produced a stark contrast. Among low-trust firms, a one-standard-deviation increase in pessimistic debt beliefs raised one-year inflation expectations by about 0.5 percentage points and three-year expectations by roughly 1.4 percentage points. High-trust firms barely responded at all: a small bump at one year and no detectable movement at three.
The researchers also split firms by their pre-existing expectations for future ECB policy rates. The inflation response was concentrated among firms that already expected the ECB to keep rates relatively low. Firms expecting higher rates showed little reaction, consistent with the interpretation that the response operates through beliefs about whether the central bank will tighten enough.
Ruling out a demand-side story
One alternative explanation is straightforward: maybe pessimistic foreign debt news signals higher foreign spending, more demand for German exports, and higher inflation through the usual channels. The evidence doesn’t support that reading. Firms did not raise their expectations for German GDP growth in response to the pessimistic news. If anything, low-trust firms became more uncertain about future growth, which is hard to reconcile with a rosy demand story.
The authors also checked whether firms simply updated their views about German fiscal policy. They didn’t: expected tax and spending increases roughly canceled, leaving expected German deficits essentially unchanged.
A test using a German fiscal shock
The researchers also examined a real-world event to test their interpretation. In March 2025, Germany’s incoming government announced an unexpected €500 billion debt-financed infrastructure fund that would bypass the constitutional debt brake. German 10-year yields jumped by more than 30 basis points, and media coverage was extensive.
Using an event-study design comparing firms surveyed in the three days before and after the announcement, the authors found no detectable movement in German firms’ inflation expectations at any horizon. Even low-trust firms did not revise upward. The authors interpret this asymmetry as consistent with their framework: firms treat debt news from the fiscal anchor of the union differently from debt news about fiscally fragile members. In Germany’s case, firms apparently expect the debt to be repaid through future surpluses rather than through inflation.
What it means in practice
For central bankers, the results suggest that trust is not a soft or ornamental concept. It shapes how the same piece of fiscal news gets translated into inflation expectations, and it does so in ways that differ across firms in the same country. The authors interpret this as evidence that a substantial share of German firms already assign meaningful probability to a fiscal-dominance scenario, and that pessimistic news about high-debt euro-area members reinforces that belief for those firms in particular.
A few caveats are worth flagging. The experiment measures expectations, not actual pricing behavior; the one-year effects on planned prices, wages, employment, and investment were small and statistically indistinguishable from zero in the immediate aftermath of the treatment. The authors suggest firms may treat long-run debt projections as macroeconomic background rather than as an immediate trigger for pricing decisions. The sample is also limited to German firms, so how firms in other euro-area countries would react to the same news remains an open question.
