Fiscal Activism and Price Volatility: Evidence from Advanced and Emerging Economies

Abstract

Using a panel of 54 countries between 1980 and 2013, we find empirical support for the view that changes in the fiscal policy stance (year-on-year change in the cyclically adjusted primary balance) have a significant positive correlation with inflation volatility. An increase in the volatility of discretionary fiscal policies by one standard deviation raises inflation volatility between 5 and 6 percent. Moreover, results using alternatively different inflation volatility proxies confirm that an expansionary fiscal stance increases price volatility. Another relevant outcome is that in a context of economic expansions (recessions) the harmful impact of fiscal activism on price volatility is soften (heightened), while the negative impact of fiscal activism on price stability is higher when fiscal policy is expansionary. Finally, fiscal activism fuels inflation volatility much more pronouncedly in emerging market economies vis-a-vis advanced economies.