IDEAS home Printed from https://ideas.repec.org/p/ise/remwps/wp03032023.html
   My bibliography  Save this paper

Fiscal Sustainability and the Role of Inflation

Author

Listed:
  • António Afonso
  • José Alves
  • Olegs Matvejevs
  • Olegs Tkacevs

Abstract

We examine the relationship between inflation and fiscal sustainability with a two-step approach. In the first step, we estimate to estimate a country-specific time-varying measure of fiscal sustainability using the fiscal reaction function. This function captures the response of the primary balance to changes in the public debt ratio. In the second step, we examine how various measures of inflation such as headline inflation, core inflation, energy inflation, and food inflation affect the estimate of fiscal sustainability found previously. Our findings indicate that higher inflation rates contribute positively to the measure of fiscal sustainability, specifically through core inflation causing an improvement in fiscal sustainability, while the effect of energy inflation is conversely found to be negligible or even negative. These results imply that the initial burst of inflation caused by the energy price shock in 2021 probably did not help improve fiscal sustainability, whereas the subsequent high core inflation had a positive effect.

Suggested Citation

  • António Afonso & José Alves & Olegs Matvejevs & Olegs Tkacevs, 2023. "Fiscal Sustainability and the Role of Inflation," Working Papers REM 2023/0303, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    • Handle: RePEc:ise:remwps:wp03032023
    as

    Download full text from publisher

    File URL: https://rem.rc.iseg.ulisboa.pt/wps/pdf/REM_WP_0303_2023.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Mauro, Paolo & Romeu, Rafael & Binder, Ariel & Zaman, Asad, 2015. "A modern history of fiscal prudence and profligacy," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 55-70.
    2. Ms. Eliane A. Cardoso, 1998. "Virtual Deficits and the Patinkin Effect," IMF Working Papers 1998/041, International Monetary Fund.
    3. Mendoza, Enrique G. & Ostry, Jonathan D., 2008. "International evidence on fiscal solvency: Is fiscal policy "responsible"?," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1081-1093, September.
    4. Atish R. Ghosh & Jun I. Kim & Enrique G. Mendoza & Jonathan D. Ostry & Mahvash S. Qureshi, 2013. "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies," Economic Journal, Royal Economic Society, vol. 0, pages 4-30, February.
    5. Eliana Cardoso, 1998. "Virtual Deficits and the Patinkin Effect," IMF Staff Papers, Palgrave Macmillan, vol. 45(4), pages 619-646, December.
    6. Henning Bohn, 1998. "The Behavior of U. S. Public Debt and Deficits," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(3), pages 949-963.
    7. 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.
    8. Haug, Alfred A, 1995. "Has Federal Budget Deficit Policy Changed in Recent Years?," Economic Inquiry, Western Economic Association International, vol. 33(1), pages 104-118, January.
    9. António Afonso & Christophe Rault, 2010. "What do we really know about fiscal sustainability in the EU? A panel data diagnostic," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 145(4), pages 731-755, January.
    10. Magazzino, Cosimo & Brady, Gordon L. & Forte, Francesco, 2019. "A panel data analysis of the fiscal sustainability of G-7 countries," The Journal of Economic Asymmetries, Elsevier, vol. 20(C).
    11. Hatemi-J, Abdulnasser, 2002. "Fiscal policy in Sweden: effects of EMU criteria convergence," Economic Modelling, Elsevier, vol. 19(1), pages 121-136, January.
    12. Aldama, Pierre & Creel, Jérôme, 2019. "Fiscal policy in the US: Sustainable after all?," Economic Modelling, Elsevier, vol. 81(C), pages 471-479.
    13. Sims, Christopher A, 1994. "A Simple Model for Study of the Determination of the Price Level and the Interaction of Monetary and Fiscal Policy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(3), pages 381-399.
    14. Schlicht, Ekkehart, 2003. "Estimating Time-Varying Coefficients With the VC Program," Discussion Papers in Economics 34, University of Munich, Department of Economics.
    15. António Afonso & José Carlos Coelho, 2022. "Fiscal sustainability, fiscal reactions, pitfalls and determinants," Working Papers REM 2022/0219, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    16. Trehan, Bharat & Walsh, Carl E., 1988. "Common trends, the government's budget constraint, and revenue smoothing," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 425-444.
    17. António Afonso & José Alves & José Carlos Coelho, 2023. "Determinants of the degree of fiscal sustainability," Working Papers REM 2023/0255, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    18. Hamilton, James D & Flavin, Marjorie A, 1986. "On the Limitations of Government Borrowing: A Framework for EmpiricalTesting," American Economic Review, American Economic Association, vol. 76(4), pages 808-819, September.
    19. António Afonso & João Jalles, 2014. "A longer-run perspective on fiscal sustainability," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 41(4), pages 821-847, November.
    20. Cochrane, John H, 2001. "Long-Term Debt and Optimal Policy in the Fiscal Theory of the Price Level," Econometrica, Econometric Society, vol. 69(1), pages 69-116, January.
    21. Schlicht, Ekkehart, 2021. "VCC - A Program for Estimating Time-Varying Coefficients. Console Version With Source Code in C," Discussion Papers in Economics 75514, University of Munich, Department of Economics.
    22. repec:hal:spmain:info:hdl:2441/7suq9gqkp186e8d6eou29dipgk is not listed on IDEAS
    23. Nilss Olekalns, 2000. "Sustainability and Stability? Australian Fiscal Policy in the Twentieth Century: A Reply," Australian Economic Papers, Wiley Blackwell, vol. 39(3), pages 399-401, September.
    24. António Afonso & Michael G. Arghyrou & Alexandros Kontonikas, 2014. "Pricing Sovereign Bond Risk In The European Monetary Union Area: An Empirical Investigation," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 19(1), pages 49-56, January.
    25. Quintos, Carmela E, 1995. "Sustainability of the Deficit Process with Structural Shifts," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(4), pages 409-417, October.
    26. Checherita-Westphal, Cristina & Žďárek, Václav, 2017. "Fiscal reaction function and fiscal fatigue: evidence for the euro area," Working Paper Series 2036, European Central Bank.
    27. Karsten Staehr & Oļegs Tkačevs & Katri Urke, 2024. "Fiscal performance under inflation and inflation surprises: evidence from fiscal reaction functions for the euro area," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 160(4), pages 1477-1504, November.
    28. Mr. Serhan Cevik & Fedor Miryugin, 2023. "It’s Never Different: Fiscal Policy Shocks and Inflation," IMF Working Papers 2023/098, International Monetary Fund.
    29. Nilss Olekalns, 2000. "Sustainability and Stability? Australian Fiscal Policy in the Twentieth Century," Australian Economic Papers, Wiley Blackwell, vol. 39(2), pages 138-151, June.
    30. António Afonso & José Alves & João Tovar Jalles, 2021. "Fiscal Reaction Functions in the EU: A Tale of “r-g” and Whether it Matters," Revue française d'économie, Presses de Sciences-Po, vol. 0(3), pages 65-101.
    31. Don Patinkin, 1993. "Israel's Stabilization Program of 1985, or Some Simple Truths of Monetary Theory," Journal of Economic Perspectives, American Economic Association, vol. 7(2), pages 103-128, Spring.
    32. Hakkio, Craig S & Rush, Mark, 1991. "Is the Budget Deficit "Too Large?"," Economic Inquiry, Western Economic Association International, vol. 29(3), pages 429-445, July.
    33. Olivier Blanchard & Alvaro Leandro & Jeromin Zettelmeyer, 2021. "Redesigning EU fiscal rules: from rules to standards," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 36(106), pages 195-236.
    34. Afonso, António & Jalles, João Tovar, 2020. "A Note On Inflation Dynamics, Price Volatility, And Fiscal Activism," Macroeconomic Dynamics, Cambridge University Press, vol. 24(5), pages 1299-1313, July.
    35. Bohn, Henning, 2007. "Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint?," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1837-1847, October.
    36. Tran, Ngan, 2018. "Debt threshold for fiscal sustainability assessment in emerging economies," Journal of Policy Modeling, Elsevier, vol. 40(2), pages 375-394.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Afonso, António & Coelho, José Carlos, 2024. "Drivers of fiscal sustainability: A time-varying analysis for Portugal," International Economics, Elsevier, vol. 178(C).
    2. Hyejin Ko, 2020. "Measuring fiscal sustainability in the welfare state: fiscal space as fiscal sustainability," International Economics and Economic Policy, Springer, vol. 17(2), pages 531-554, May.
    3. 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.
    4. Juan Carlos Cuestas & Luis A. Gil-Alana & Laura Sauci, 2020. "Public finances in the EU-27: Are they sustainable?," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 47(1), pages 181-204, February.
    5. António Afonso & José Carlos Coelho, 2022. "Public Finances Solvency in the Euro Area: True or False?," CESifo Working Paper Series 9935, CESifo.
    6. Afonso, António & Coelho, José Carlos, 2023. "Public finances solvency in the Euro Area," Economic Analysis and Policy, Elsevier, vol. 77(C), pages 642-657.
    7. Karsten Staehr & Oļegs Tkačevs & Katri Urke, 2024. "Fiscal performance under inflation and inflation surprises: evidence from fiscal reaction functions for the euro area," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 160(4), pages 1477-1504, November.
    8. Afonso, António & Agnello, Luca & Furceri, Davide & Sousa, Ricardo M., 2011. "Assessing long-term fiscal developments: A new approach," Journal of International Money and Finance, Elsevier, vol. 30(1), pages 130-146, February.
    9. Magazzino, Cosimo & Brady, Gordon L. & Forte, Francesco, 2019. "A panel data analysis of the fiscal sustainability of G-7 countries," The Journal of Economic Asymmetries, Elsevier, vol. 20(C).
    10. Olaoye, Olumide Olusegun & Olomola, P.A., 2022. "Empirical analysis of asymmetry phenomenon in the public debt structure of Sub-Saharan Africa's five biggest economies: A Markov-Switching model," The Journal of Economic Asymmetries, Elsevier, vol. 25(C).
    11. Paniagua, Jordi & Sapena, Juan & Tamarit, Cecilio, 2017. "Fiscal sustainability in EMU countries: A continued fiscal commitment?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 50(C), pages 85-97.
    12. Beqiraj, Elton & Fedeli, Silvia & Forte, Francesco, 2018. "Public debt sustainability: An empirical study on OECD countries," Journal of Macroeconomics, Elsevier, vol. 58(C), pages 238-248.
    13. António Afonso & José Alves & José Carlos Coelho, 2023. "Determinants of the Degree of Fiscal Sustainability," CESifo Working Paper Series 10225, CESifo.
    14. María del Carmen Ramos-Herrera & Simón Sosvilla-Rivero, 2020. "Fiscal Sustainability in Aging Societies: Evidence from Euro Area Countries," Sustainability, MDPI, vol. 12(24), pages 1-20, December.
    15. Olumide Olusegun Olaoye & Phillip A. Olomola, 2023. "Sub‐Saharan Africa's rising public debt stock: Is there a cause for concern?," South African Journal of Economics, Economic Society of South Africa, vol. 91(1), pages 85-115, March.
    16. Bajo-Rubio, Oscar & Díaz-Roldán, Carmen & Esteve, Vicente, 2014. "Deficit sustainability, and monetary versus fiscal dominance: The case of Spain, 1850–2000," Journal of Policy Modeling, Elsevier, vol. 36(5), pages 924-937.
    17. António Afonso & José Alves & Serena Ionta, 2023. "The effects of monetary policy surprises and fiscal sustainability regimes in the Euro Area," Working Papers REM 2023/0281, ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa.
    18. António Afonso & João Tovar Jalles, 2012. "Revisiting fiscal sustainability: panel cointegration and structural breaks in OECD countries," Working Papers Department of Economics 2012/29, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    19. Gordon L. Brady & Cosimo Magazzino, 2018. "Sustainability and comovement of government debt in EMU Countries: A panel data analysis," Southern Economic Journal, John Wiley & Sons, vol. 85(1), pages 189-202, July.
    20. António Afonso, 2005. "Fiscal Sustainability: The Unpleasant European Case," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 61(1), pages 19-44, March.

    More about this item

    Keywords

    fiscal sustainability; fiscal reaction function; time-varying coefficients; euro area; inflation; core inflation; panel data.;
    All these keywords.

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ise:remwps:wp03032023. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sandra Araújo (email available below). General contact details of provider: https://rem.rc.iseg.ulisboa.pt/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.