Inflation and fiscal policy: is there a threshold effect in the fiscal reaction function?

Clémence Briodeau and Cristina Checherita-Westphal
Authors registered in the RePEc Author Service: Cristina Checherita Westphal

No 2880, Working Paper Series from European Central Bank

Abstract: This paper estimates a fiscal reaction function (FRF) framework for euro area countries to test for the impact of changes in inflation on fiscal policy. We find evidence of non-linear short-term effects of HICP inflation on the primary balance after controlling for other relevant factors. Over the period 1999-2022, we unveil an inverse U-turn relationship and an inflation turning point - beyond which its short-term (contemporaneous) impact on the primary balance starts being negative - at somewhat above 4% for the sample of mature euro area economies (EA-12, first twelve EA members) and around 6% for the whole sample of euro area countries in 2022 (EA-19). Using an alternative measure of “inflation surprise” (available for the period 2003-2022) yields robust results in the larger EA-19 sample and lowers the threshold to just below 5%. In terms of channels, the non-linear effects are found to propagate through both the primary expenditure and the revenue ratio (more robustly through the former) in the EA-12 sample, while only the combined effect on the primary balance seems to prevail for EA-19. These results reflect primarily the most recent high inflation episode and indicate that in such conditions inflation can be costly for public finance flows even in the shorter run. JEL Classification: H60, E62, E31, C33

Keywords: euro area; fiscal reaction function; inflation; panel models (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-eur and nep-mon
Note: 1790315
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Inflation and Fiscal Policy: Is There a Threshold Effect in the Fiscal Reaction Function? (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20232880

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