VAT rate shocks and inflation: a theoretical and empirical analysis for Greece

This paper evaluates the effectiveness of Value Added Tax (VAT) reductions as a tool to mitigate inflation in Greece, combining empirical evidence with structural macroeconomic analysis. First, the estimation of a small-scale structural vector autoregression (SVAR) model reveals that temporary VAT reductions exert a statistically insignificant effect on inflation. Nevertheless, when VAT reductions are accompanied by enhancements in product market competition, the disinflationary effects become both significant and persistent. Second, the results from a Dynamic Stochastic General Equilibrium (DSGE) model calibrated to the Greek economy indicate that the short-run pass-through of VAT cuts to consumer prices is partial, ranging between 19% and 25% in the short term. This pass-through is highly influenced by structural factors and the persistence of policy interventions. Notably, permanent VAT cuts generate nearly twice the inflation pass-through compared to temporary ones. The disinflationary impact is also stronger in economies with more competitive product markets, where firms are more likely to transmit cost reductions to prices. Conversely, in economies characterised by relatively high nominal rigidities or limited domestic input use, the inflation response to VAT reductions is diminished. Overall, the results of the study demonstrate the significance of structural conditions in determining the inflationary outcomes of VAT-based fiscal measures.