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Inflation and public finances: an overview

Author

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  • Dubravko Mihaljek

    (Bank for International Settlements, Basel, Switzerland)

Abstract

This paper presents an analytical overview of the effects of inflation on government revenues, expenditure and fiscal positions. Evidence for a range of countries from the current inflation episode and that of the 1980s is compared and contrasted. The key finding is that high inflation initially boosts tax revenues and improves fiscal positions, but expenditure quickly catches up and offsets this improvement. The short-term boost is partly due to structural changes that have made modern tax systems more elastic with respect to inflation. The medium-turn deterioration reflects a shift toward spending items more responsive to inflation. The key risk is that the impression of abundant tax revenues will lead to spending programmes or tax cuts that damage public finances in the long term. As research on inflation and public finances has been dormant since the 1980s, this analysis fills a gap in our understanding of the fiscal consequences of inflation.

Suggested Citation

  • Dubravko Mihaljek, 2023. "Inflation and public finances: an overview," Public Sector Economics, Institute of Public Finance, vol. 47(4), pages 413-430.
    • Handle: RePEc:ipf:psejou:v:47:y:2023:i:4:p:413-430
    DOI: 10.3326/pse.47.4.2
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    References listed on IDEAS

    as
    1. Sebastian Beer & Mark Griffiths & Alexander Klemm, 2023. "Tax distortions from inflation: What are they? How to deal with them?," Public Sector Economics, Institute of Public Finance, vol. 47(3), pages 353-386.
    2. Frederic Boissay & Claudio Borio & Cristina Leonte & Ilhyock Shim, 2023. "Prudential policy and financial dominance: exploring the link," BIS Quarterly Review, Bank for International Settlements, March.
    3. Dubravko Mihaljek, 2021. "Interactions between fiscal and monetary policies: a brief history of a long relationship," Public Sector Economics, Institute of Public Finance, vol. 45(4), pages 419-432.
    4. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production: I--Production Efficiency," American Economic Review, American Economic Association, vol. 61(1), pages 8-27, March.
    5. Checherita-Westphal, Cristina & Dorrucci, Ettore, 2023. "Update on euro area fiscal policy responses to the energy crisis and high inflation," Economic Bulletin Boxes, European Central Bank, vol. 2.
    6. Nowotny, Ewald, 1980. "Inflation and Taxation: Reviewing the Macroeconomic Issues," Journal of Economic Literature, American Economic Association, vol. 18(3), pages 1025-1049, September.
    7. Katia Berti & Eugeniu Colesnic & Cyril Desponts & Stephanie Pamies & Etienne Sail, 2016. "Fiscal Reaction Functions for European Union Countries," European Economy - Discussion Papers 028, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    8. Diamond, Peter A & Mirrlees, James A, 1971. "Optimal Taxation and Public Production II: Tax Rules," American Economic Review, American Economic Association, vol. 61(3), pages 261-278, June.
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    More about this item

    Keywords

    inflation; tax revenue; government expenditure; fiscal balances; public debt; fiscal-monetary policy interactions; advanced economies; emerging market economies; Great Inflation;
    All these keywords.

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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