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Fiscal performance under inflation and inflation surprises: evidence from fiscal reaction functions for the Euro Area

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  • Karsten Staehr
  • Olegs Tkacevs
  • Katri Urke

Abstract

This paper estimates fiscal reaction functions to examine the importance of inflation and inflation surprises for fiscal outcomes in the euro area countries, covering the first 12 countries to join the euro area. The effect of HICP inflation on the primary fiscal balance in per cent of GDP is positive, and statistically and economically significant. The positive effect stems from both the revenue side, particularly direct taxes and indirect taxes, and the expenditure side, particularly primary current expenditures. The effects of HICP inflation on the primary balance and other fiscal outcomes appear in large part to stem from inflation surprises, which are errors in the inflation forecasts available for preparing budgets. The positive effect on the primary fiscal balance does not exhibit noticeable non-linearities.

Suggested Citation

  • Karsten Staehr & Olegs Tkacevs & Katri Urke, 2023. "Fiscal performance under inflation and inflation surprises: evidence from fiscal reaction functions for the Euro Area," Bank of Estonia Working Papers wp2023-3, Bank of Estonia, revised 20 Jun 2023.
    • Handle: RePEc:eea:boewps:wp2023-3
    DOI: 10.23656/25045520/052022/0200
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    More about this item

    Keywords

    public finances; fiscal outcome; inflation; inflation surprises;
    All these keywords.

    JEL classification:

    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus
    • H68 - Public Economics - - National Budget, Deficit, and Debt - - - Forecasts of Budgets, Deficits, and Debt
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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