Fiscal Stimulus Under Average Inflation Targeting

Abstract

The stimulus effects of expansionary fiscal policy under average inflation targeting (AIT) depends on both monetary and fiscal policy regimes. AIT features an inflation makeup under the monetary regime, but not under the fiscal regime. In normal times, AIT amplifies the short-run fiscal multipliers under both regimes while mitigating the cumulative multiplies due to intertemporal substitution. In a zero-lower-bound (ZLB) period, AIT reduces fiscal multipliers under a monetary regime by shortening the duration of the ZLB through expected inflation makeup. Under the fiscal regime, AIT has a nonlinear effect on fiscal multipliers because of the absence of inflation makeup and the presence of a nominal wealth effect.

Challenges for Monetary and Fiscal Policy Interactions in the Post-Pandemic Era

“…Box 6 presents an empirical exercise which analyses fiscal multipliers at and away from the ELB and the results are broadly in line with the existing literature. Liu et al (2023) analyse the interaction between monetary policy strategy and the impact of fiscal policy and show that the stimulus effects of fiscal policy expansions crucially depend on the extent of history-dependence of average inflation targeting.…”