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The effects of high inflation on public finances in the euro area

Author

Listed:
  • Bańkowski, Krzysztof
  • Checherita-Westphal, Cristina
  • Jesionek, Julia
  • Muggenthaler, Philip
  • Frutos, Mario Alloza
  • Avgousti, Aristoklis
  • Briodeau, Clémence
  • Brusbārde, Baiba
  • Caprioli, Francesco
  • Delobbe, Olivier
  • Hickey, Ronan
  • Italianer, Jip
  • Kivistö, Jarkko
  • Kuckuck, Jan
  • Martínez-Pagés, Jorge
  • Palášthyová, Barbora
  • Papaoikonomou, Dimitrios
  • Prammer, Doris
  • Renzi, Fabrizio
  • Roter, Mojca
  • Sant, Kurt
  • Sazedj, Sharmin
  • Schmidt, Katja
  • Schoonackers, Ruben
  • Strazdaite, Viktorija
  • Strojan-Kastelec, Andreja
  • Urke, Katri

Abstract

The recent spike in inflation, unprecedented in the history of the Economic and Monetary Union (EMU), has had major consequences for all areas of the economy, including public finances. This paper aims to provide a detailed assessment of the effects of high inflation on fiscal accounts in the euro area. Relying on the wealth of expertise in the Eurosystem – within the Working Group on Public Finance – it documents spending indexation arrangements in all euro area countries. Thanks to this knowledge, the ECB’s fiscal projection platform, which is the primary evaluation tool for this study, establishes a realistic link between prices and fiscal variables. The results of this paper bring into question the conventional wisdom on the overall positive effects of inflation on fiscal accounts. Indeed, the simulations point to adverse effects from the recent inflation surge, mainly triggered by an external supply shock, on budget balances during 2022-24. This is even without taking into account the negative impact of inflation on the real economy, mainly through monetary policy tightening. The analysis also points to the important role of the denominator effect for debt-to-GDP ratios, which may fall even in the absence of benefits for the budget balance. Finally, the analysis reveals a high degree of heterogeneity across countries. JEL Classification: C3, E3, E6

Suggested Citation

  • Bańkowski, Krzysztof & Checherita-Westphal, Cristina & Jesionek, Julia & Muggenthaler, Philip & Frutos, Mario Alloza & Avgousti, Aristoklis & Briodeau, Clémence & Brusbārde, Baiba & Caprioli, Francesc, 2023. "The effects of high inflation on public finances in the euro area," Occasional Paper Series 332, European Central Bank.
    • Handle: RePEc:ecb:ecbops:2023332
    Note: 2648110
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    References listed on IDEAS

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    Cited by:

    1. Briodeau Clémence & Checherita-Westphal Cristina, 2024. "Inflation and Fiscal Policy: Is There a Threshold Effect in the Fiscal Reaction Function?," The Economists' Voice, De Gruyter, vol. 21(2), pages 223-236.
    2. Pedro Teles & Oreste Tristani, 2024. "The Monetary Financing of a Large Fiscal Shock," Working Papers w202403, Banco de Portugal, Economics and Research Department.
    3. Checherita-Westphal, Cristina & Pesso, Tom, 2024. "Fiscal policy and inflation: accounting for non-linearities in government debt," Working Paper Series 2996, European Central Bank.
    4. Briodeau Clémence & Checherita-Westphal Cristina, 2024. "Inflation and Fiscal Policy: Is There a Threshold Effect in the Fiscal Reaction Function?," The Economists' Voice, De Gruyter, vol. 21(2), pages 223-236.

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    More about this item

    Keywords

    euro area; fiscal policy; inflation; macroeconomic simulations;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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