Fiscal policy and inflation
Fernanda Nechio
Federal Reserve Bank of San Francisco
Fiscal Policy and Sovereign Debt
IMF-CARF-TCER-Waseda University Conference
June 2024
Slides based on findings from Carvalho, Ferrero, Mazin and Nechio (2024), Carvalho and Nechio(2023), Jordà and Nechio (2023).

The views expressed herein are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Federal
Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System.

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Covid policy responses and inflation
Price inflation

U.S. historicallyReal Disposable Income per capita (2019Q4=100)

10U.S. vs OECD

Real Disposable Income: per capita (%yoy)

Median SPF fore
115

520110OECDUS0

10105-50100

2018q1−10
2019
Source: OECD Household Dashboard

2020

2021

1960

1980

2000

2020

Source: U.S. Bureau of Economic Analysis

2019q1

2020q1Counterfactual

2021q1qdate

2022q1US Core Inflation

Source: Jordà and Nechio (2023), “Inflation and Wage Growth Since the Pandemic,” European Economic Review.

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Stronger correlation between expected inflation and debt since fiscal woes
Table 1: Correlations between inflation and gross debt projections

Correlations between inflation and gross debt projections

Pre-unanch. (01/22/2018 - 08/31/2021)
Since unanch. (09/01/2021 - 01/20/2023)
Since 1st round (10/03/2022 - 01/20/2023)e∗ρ(πt+2,3− πt+2,3, Dt+5 − Dt+1 )e∗
ρ(πt+2,3− πt+2,3, Dt+8 − Dt+1 )Level
0.4***
0.68***
0.76***

Level
0.28***
0.74***
0.72***∆ 30-day
0.03
0.33***
0.59***∆ 30-day
0.09*
0.27***
0.3*

e∗Notes: Correlations between deviations of inflation expectations from target (πt+2,3− πt+2,3) and gross debt/GDP forecast
slopes for 5- (Dt+5 − Dt+1 ) and 8- (Dt+8 − Dt+1 ) years ahead. 90/95/99% confidence level indicated with ∗/∗∗/∗∗∗ , respectively,
based on Newey-West standard errors. Sources: Banco Central do Brasil and authors’ calculations.

• Since 2018, professionals survey projections for debt/GDP pathe∗• Correlations
between(πt+2,3) andbetween(Dt+hinflation− Dt+1expectations), h = {5,and8} debtThe table shows
an increasein −theπt+2,3
correlation

forecast
slopessince unanchoring
began,sinceand anadditional increasesince the election for the• Sharp
increasein correlations
expectations
unanchored5-yearhorizon. Thisevidence
gives
to election
our conjecture that unanchoring of inflation• Additional
step-upclose
to credence
Oct. 2022
expectations and fiscal concerns are once again related in the ongoing episode.

• These held despite BCB’s contractionary stance and inflation declining sharply
The combination of fiscal concerns and unanchored expectations in a high-inflation environ-ment is all too familiar for Brazil. The previous episodes show a range of factors were needed
to bring back confidence and reanchor inflation expectations. The BCB had to act strongly.

Source: Carvalho and Nechio (2023), “Challenges to Disinflation: The Brazilian Experience,” Brookings Papers on Economic Activity.

Importantly, actions and expectations of sound fiscal policy were key to restoring market con-3/5

Credibility can be challenged in advanced economies• U.K. long-term expectations rose andfell following fiscal announcements• Reported concerns about fiscale)
U.K. inflation expectations (πt+5• U.S. expectations rose after GFC• But remained well anchored since thepandemice)
U.S. inflation expectations (πt+5,103.5

3.0

2.5

2.0

1.5

Source: Carvalho and Nechio (2023), “Challenges to Disinflation: The Brazilian Experience,” Brookings Papers on Economic Activity.

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Fiscal spending and r-star• Estimates from ECM on panel of OECD economies from 1979-2019• Interaction of variables with degree of financial openness• Global factors summarized by a global real rate variable
Source: Carvalho, Ferrero, Mazin and Nechio (2024), “Demographics and Real Interest Rates across Countries and over Time.”

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