Inflation and the role of macroeconomic policies: A model for the case of Denmark.

• We explore the role of monetary, fiscal and income policies in the face of exogenous inflationary shocks in an empirical stock-flow consistent model while using Denmark as a case study. • We find that a contractionary monetary policy can lead to a modest reduction in inflation at the cost of further contracting the economy. • We find that a close coordination of fiscal and income policies can help reduce the effects of adverse shocks to income without increasing inflation. • We explore the dynamics of public debt, find that of all the policies implemented, monetary policy has the most dramatic effects on public debt sustainability. This paper provides an assessment of the different channels through which monetary, fiscal and income policies affect prices and output in a small open economy and discuss which policy measures are effective and feasible in the face of inflationary shocks. We build a stock-flow-consistent model using sectoral data for Denmark. We then replicate the inflationary environment faced by Denmark and several other countries after the Covid-19 crisis. While taking monetary tightening as a forced policy response for a small open economy with fixed exchange rate, we explore a number of policies that, within the current institutional and legal framework, can potentially mitigate the effects of inflation. Our conclusion is that a close coordination of fiscal and income policies can help reduce the effects of adverse shocks to income without increasing inflation. Furthermore, we find that of all the policies implemented, monetary policy has the most dramatic effects on public debt sustainability. [ABSTRACT FROM AUTHOR]