Fiscal Policy Variables Shock Impact on Inflation and GDP Growth

Abstract

Despite the theoretical diverging views about the fiscal policy effects on the price level, we establish different effects between total tax revenue and final consumption expenditure by government. Evidence suggests that taxes on income, goods and services, fuel levy and VAT accentuate the effects of monetary policy tightening shocks on the decline in GDP growth. But monetary policy is tightened by raising the repo rate to curb inflationary pressures irrespective of developments in the tax components. Nonetheless, the degree to which the repo rate increases varies given the different amplifying abilities of the tax components. We find heterogeneous results as expected. For instance, the repo rate increases more in the presence of income tax (personal and corporate) and taxes on goods and services. Furthermore, evidence indicates that since 2013 the counterfactual inflation rate has exceeded actual inflation, suggesting the dominance of final consumption by government over total tax revenue.