Can Fiscal Consolidation Announcements Help Anchor Inflation Expectations?

IMF Working Papers, March 15, 2024

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Quarterly data and a novel database on fiscal policy consolidation announcements are used for a sample of advanced economies and emerging markets to quantify the effects of fiscal tightening on inflation expectations.
Sample scope: advanced economies and emerging markets.
Methods: narrative identification of fiscal consolidation announcements; analysis of inflation expectations at multiple horizons.

Fiscal consolidation announcements reduce inflation expectations over the medium-term (three and five-years ahead), but not in the short-term (one-year ahead).
There is some evidence that consolidation announcements reduce “disagreement” about expected future inflation at longer horizons.
The inflation anchoring role of consolidation announcements is enhanced by:
- the strength of a country’s fiscal and monetary frameworks, and
- when fiscal and monetary policy work in tandem.
Initial conditions matter: inflation expectation’s response to consolidation announcements is larger in periods of high contemporaneous inflation.
The effectiveness of fiscal consolidation in controlling realized inflation depends greatly on the response of inflation expectations to consolidation announcements.
Policy implication: fiscal policy is crucial to anchor inflation expectations and is a key element of a credible disinflationary process.

Strength of institutions:
- Stronger fiscal frameworks increase the inflation-anchoring effect of consolidation announcements.
- Stronger monetary frameworks likewise enhance the effect.
Policy coordination:
- When fiscal and monetary policy work in tandem, consolidation announcements have a larger anchoring effect.
Macroeconomic state dependence:
- High contemporaneous inflation amplifies the response of inflation expectations to consolidation announcements.