High debt amplifies inflation volatility through firms' attention

Higher debt raises revenue taxes in the model, reducing the profit stakes of mispricing but making desired prices more sensitive to tax changes.

These opposing forces produce U-shaped relationships between debt, attention and inflation volatility, with volatility lowest near 60 percent debt-to-GDP.

Without fiscal uncertainty, attention instead declines with debt.

Raising debt from 100 to 175 percent lifts annual inflation volatility from around 1.65 to 2.0 percent; cumulative tax-shock effects over four years roughly double.

Fixed attention largely removes the volatility increase.

Faster tax-based debt adjustment lowers volatility at low debt but raises it at high debt.

Tax increases accompanied by greater uncertainty amplify inflation and output responses, especially at high debt.

The European Central Bank (ECB)/European Commission enterprise finance survey supplies 62,837 observations from 35,769 firms across 11 euro-area countries, Q3 2023–Q1 2026.

Expected cost-to-price passthrough rises from 0.218 at Ireland's 32.8 percent debt-to-GDP ratio to 0.318 at Greece's 171.5 percent, roughly 45 percent.

Country-wave fixed effects and firm controls underpin the estimates.

The debt interaction is positive in all 40 robustness specifications and meets the 5 percent one-sided significance threshold in 37; excluding Italy weakens significance.