- When the inflation is generated by an external shock and runs at a high level, its positive impact on public finances can be reversed
- According to the simulations, it takes one year for the euro area budget balance to be adversely affected by the inflation surge
- In subsequent years, however, spending pressures intensify and more than offset the benefits on the revenue side, leading to nearly 0.5% of GDP deterioration in the budget balance level in 2024
- Beyond the short run, euro area public finances may turn out to be negatively affected by the current high inflation episode
- This would be the case even without considering governments’ discretionary policy response to the high energy prices and inflation
- The monetary policy reaction required to avoid this inflation shock leading to undue second-round effects is being translated into an increase in interest payments on government debt
- Beyond the short run and conditional on the monetary policy reaction, a negative impact on economic activity from an adverse supply shock may outweigh the positive impact of higher inflation on debt ratios
- Full economic bulletin
This is contrarian to the view of some that governments might benefit as debt is inflated away and nominal tax revenues rise. So, that is definitely some food for thought for the longer-term macro picture across the euro area should inflation continue to stay at a high level in the coming year(s).
