3/2023 Karsten Staehr, Oļegs Tkačevs, Katri Urke. Fiscal Performance under Inflation and Inflation Surprises: Evidence from Fiscal Reaction Functions for the Euro Area
Working Papers of Eesti Pank 3/2023
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.
JEL codes: H6, H62, H68, E31
Keywords: public finances; fiscal outcome; inflation; inflation surprises