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Fiscal Policy and Inflation in the Euro Area

Working paper 820
Working Papers

Published: 25 November 2024

By: Guido Ascari Dennis Bonam Lorenzo Mori Andra Smadu

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.

Keywords: E30; E31;E50
JEL codes inflation; fiscal policy; monetary policy; global supply chain pressures,;vector autore- gression

Working paper no. 820

820 - Fiscal Policy and Inflation in the Euro Area

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Research highlights

  •  Prevailing narrative: EA inflation was largely driven by   supply shocks, while  US inflation was mainly   fueled   by demand forces
  •  Specifically, in the US big fiscal expansion, small role   for fiscal policy in the EA
  •  We quantify empirically the effects of fiscal shocks on   EA inflation, using Bayesian structural VAR   analysis   with six different shocks
  •  Contrary to the prevailing narrative fiscal policy   shocks significantly contributed to the EA inflation     surge
  •  The contribution has been delayed and gradual, as   features of NEXTGENEU and the suspension of the   SGP would suggest
  •  Both demand and supply shocks played a sizeable   role, with demand shocks being relatively more   important

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