Fiscal sustainability and the role of inflation

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.info:eu-repo/semantics/publishedVersio

Explaining government revenue windfalls and shortfalls: an analysis for selected EU countries

In recent years, government revenues in many EU countries experienced significant and erratic changes, which, a priori, could not be fully explained by macroeconomic developments or by discretionary fiscal policy measures. We investigate this issue by estimating “unexplained” changes in tax and social contribution revenues, based on proxies for tax revenue bases and elasticities commonly used for forecasting or cyclically adjusting government revenues and taking into account estimates of the impact of legislation changes. This is done for a selection of EU countries, including the “big five” euro area countries (Germany, Spain, France, Italy and the Netherlands) together with Ireland, Latvia and Portugal. We also undertake the same exercise using alternative tax base proxies, either taken from forecasting models or on the basis of our knowledge of the tax system in each country. The results show that, in the aggregate, revenue windfalls and shortfalls have exhibited a broadly cyclical pattern, driven mainly by developments in profit-related taxes and, to a somewhat lesser extent, VAT. Other, more structural factors also play a role, such as declining consumption of fuel and tobacco, as well as factors specific to individual countries, such as developments in property markets. The estimated revenue windfalls and shortfalls can explain a substantial proportion of changes in the euro area cyclically adjusted budget balance over the period 1999-2007. Since these unexplained revenue changes have exhibited a largely cyclical character and might therefore be viewed as partly temporary, this highlights the importance of a careful interpretation of fiscal indicators adjusted for the economic cycle. Except in a small number of cases, the results do not change significantly when alternative tax base proxies are used, suggesting that the potential for improving existing indicators by a better matching of taxes to their bases is likely to be limited. JEL Classification: H20, H68, E62cyclical adjustment, Fiscal forecasting, tax revenues

Fiscal sustainability and policy implications for the euro area" by

Abstract In this paper we examine the sustainability of euro area public finances against the backdrop of population ageing. We critically assess the widely used projections of the Working Group on Ageing Populations (AWG) of the EU's Economic Policy Committee and argue that ageing costs may be higher than projected in the AWG reference scenario. Taking into account adjusted headline estimates for ageing costs, largely based upon the sensitivity analysis carried out by the AWG, we consider alternative indicators to quantify sustainability gaps for euro area countries. With respect to the policy implications, we assess the appropriateness of different budgetary strategies to restore fiscal sustainability taking into account intergenerational equity. Our stylised analysis based upon the lifetime contribution to the government's primary balance of different generations suggests that an important degree of pre-funding of the ageing costs is necessary to avoid shifting the burden of adjustment in a disproportionate way to future generations. For many euro area countries this implies that the medium-term targets defined in the context of the revised stability and growth pact would ideally need to be revised upwards to significant surpluses

Parameter heterogeneity, persistence and cross-sectional dependence: new insights on fiscal policy reaction functions for the Euro area

A number of novelties have emerged in the study of the discretionary fiscal policy within the Euro area during the last decade. Among the others, the availability of up-to-date information on fiscal indicators for the years following the Great Recession, the introduction of cutting-edge econometric methods, and a renewed interest about the sustainability of fiscal policy and public debt. The aim of this paper is to address the challenges posed by the estimation of the discretionary fiscal reaction function for the Euro area. We exploit recently introduced testing and estimation strategies for heterogeneous dynamic panels with cross-sectional dependence and propose a new parsimonious approach. Using real-time data over the period 1996-2016, we investigate whether the fiscal policy reaction function is still a benchmark after the Great Recession. We find evidence of strong cross-sectional dependence in the panel, and clear support to a valid cointegration relationship among the main determinants of the function. Newly added covariates, such interest rate spreads, come out to play a relevant role in explaining discretionary actions

The Impact of Fiscal Policy on Prices: Does the Fiscal Theory of Price Level Matter in Latvia?

The paper studies the indirect impact of fiscal policy on prices. Exploring VAR in two variables, primary balance ratio to GDP and public debt ratio to GDP, and calculating the impulse response functions to innovations in the former variable, it supposes an evidence of the exogeneity of Latvian general government budget balance. Borrowing from the recently developed Fiscal Theory of Price Level (FTPL) it implies that deterioration of the budget balance may lead to an upward price adjustment needed to assure fiscal solvency.Fiscal policy, budget balance

Cyclically Adjusted Balance of Latvia's General Government Consolidated Budget

This study estimates cyclically adjusted balances of Latvia's general government consolidated budget using methodologies of the ESCB and OECD and assesses the consistency of the implemented fiscal policy with the EU fiscal policy framework. During the period of rapid economic growth the Latvian government pursued fiscal expansion instead of ensuring budgetary consolidation in cyclically adjusted terms. Fiscal policy of the Latvian government has been inconsistent with the requirements of the Stability and Growth Pact and has exerted an additional pressure on consumer prices and the current account.cyclically adjusted budget balance, Stability and Growth Pact, pro-cyclical fiscal policy, budgetary elasticity