Fiscal Policy and Inflation Volatility

Abstract

Among the harmful effects of inflation, the negative consequences of inflation volatility are of particular concern. These include higher risk premia, hedging costs and unforeseen redistribution of wealth. This paper presents panel estimations for a sample of OECD countries which suggest that activist fiscal policies may have an important impact on CPI inflation volatility. Major results are robust for unconditional and conditional inflation volatility, the latter derived from country-specific GARCH models, and across different data frequencies, time periods and econometric methodologies.

From a policy perspective, these results point to the possibility of further destabilising effects of discretionary fiscal policies, in addition to their potential to destabilise output.

Keywords: inflation volatility, fiscal policy

JEL Classification: E31, E62