Unconventional Fiscal Policy in Times of High Inflation by Mai Chi Dao, Allan Dizioli, Chris Jackson, Pierre-Olivier Gourinchas, and Daniel Leigh published by European Central Bank (6/2023).
The surge in energy prices in 2022 has been a defining factor behind the increase in euro área inflation. We assess the impact of “unconventional fiscal policy,” defined as the set of fiscal measures, possibly expansionary, motivated by a desire to mute the effects of the increase in energy prices and to lower inflation. Overall, we find that these unconventional measures reduced euro área inflation by 1 to 2 percentage points in 2022 and may avoid an undershoot later on. The net effect is to keep inflation nearer to the target. About one-third to one-half of the reduction in 2022 reflects the direct effects of the measures on headline inflation, with much of the remainder reflecting the lower pass-through to core inflation. The fiscal measures were deficit-financed but had limited effects on raising inflation by stimulating demand and instead modestly helped to stabilize longer-term inflation expectations. Looking ahead, the prospective decline in inflation in the euro area is partly due to fortunate circumstances, with energy prices falling from their 2022 peaks and their pass-through effects fading, and with less economic overheating than in economies such as the United States. Implementing similar measures in the face of a more persistent increase in energy prices, or in a more overheated economy, would have caused a more persistent rise in core inflation.