Working papers

We investigate the relationship between fiscal policy and inflation dynamics in the euro area, with a focus on the post-pandemic inflation surge. Using a BVAR identified via sign restrictions, we disentangle the effects of various demand- and supply-side shocks, including fiscal policy, on inflation. First, while both positive demand and adverse supply shocks contributed to the inflation surge, demand shocks were relatively more important. Second, fiscal stimulus played a substantial and progressively increasing role, particularly in influencing domestic-based measures of inflation. Finally, the relative impact of fiscal shocks on inflation dynamics varies across (selected) euro area countries.

SUERF Policy Brief

We show that a negative relative demand shock in a sector with downwardly rigid prices, like the service sector, can generate substantial inflation. Such a shock induces an equilibrium decline in the relative price of services. If price adjustment costs are non-existent or symmetric, then this takes place through a simultaneous decline in services prices and increase in goods prices, resulting in, on net, little inflation. If prices in the services sector are downwardly rigid, however, this takes place mostly through an increase in goods prices, resulting in inflation. To illustrate the relevance of this mechanism in practice we provide evidence on the downward rigidity of person-to-person service prices during the Covid pandemic of 2020-2021. We then introduce downward price rigidities in a multisector New-Keynesian model and show how they can result in inflationary relative demand shocks.

Some countries currently face historically low interest rates on government debt due to a positive 'convenience yield' arising from an excess demand for safe and liquid assets. This low interest rate environment has raised interest in the role of fiscal stabilization policy. We study the convenience yield and its implications for fiscal policy in a New Keynesian model where households derive utility from government bonds. We find that the convenience yield expands the set of sustainable fiscal policies and renders counter-cyclical fiscal policy successful in stabilizing business cycle fluctuations. Conveniently, fiscal policies that stabilize output rather than debt are feasible, welfare enhancing and can even reduce the risk of exploding debt dynamics if the convenience yield is positive.

Slides

INFER Brief

We estimate the impact of tax shocks on output across different stages of the business cycle. We do this for a panel of nine advanced economies using a harmonized dataset of narratively identified exogenous tax changes and a smooth transition local projection model. The output response to an exogenous tax shock is significant, but only during economic expansions. In recessions, the tax multiplier is insignificant, both in the short- and long run. We also find that, during booms, output only responds to tax hikes and is unresponsive to tax cuts. The results on the state-dependent and asymmetric effects of tax shocks are robust to a number of alternative model specifications and definitions of the business cycle.