The Impact of Fiscal Policy on Inflation Expectations

IMF Working Papers, November 7, 2025

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Episodes of significant fiscal adjustment are associated with statistically significant changes in inflation expectations in emerging market economies (EMs) while the responses are muted in advanced economies (AEs).
The relationship between fiscal policy and inflation expectations is more pronounced in high-inflation environments and under weak fiscal positions.
Market perceptions of sovereign risk, as well as monetary and exchange rate frameworks, influence the transmission of fiscal policy to inflation expectations.
Empirical results suggest that it is especially important for EMs to implement prudent fiscal policy as it may help reduce inflationary pressures and inflation expectations.

Episodes of significant fiscal adjustment are identified using both quantitative thresholds and a narrative approach.

Advanced economies (AEs):
- Responses of inflation expectations to fiscal adjustments are muted.
Emerging market economies (EMs):
- Statistically significant changes in inflation expectations are observed following fiscal adjustment episodes.
- Effects are amplified in high-inflation environments and when fiscal positions are weak.

Market perceptions of sovereign risk shape how fiscal policy affects inflation expectations.
Monetary frameworks and exchange rate frameworks influence the transmission of fiscal policy to inflation expectations.

For emerging market economies (EMs):
- Implement prudent fiscal policy to help reduce inflationary pressures and inflation expectations.
Consideration of sovereign risk perceptions and adherence to credible monetary and exchange rate frameworks can modulate the inflation-expectation effects of fiscal actions.