The design of fiscal policy by governments can help central banks in their fight against inflation and, therefore, limit the need to raise interest rates, while better protecting the most vulnerable groups , according to the International Monetary Fund (IMF).
“When central banks act alone, without the support of fiscal policy, they need to substantially increase interest rates to combat inflation,” the director of the IMF’s Fiscal Affairs Department, Vitor Gaspar, points out in an article, pointing out that the fiscal adjustment “allows interest rates to rise less to contain inflation.”
In this way, the international institution maintains that, although monetary policy “is in the driver’s seat in the battle against inflation”, fiscal policy can help with the design of a well-targeted fiscal adjustment to support the central bank in the search for price stability, while protecting the vulnerable from the crisis due to the increase in the cost of living.
Public finances matter for inflation through their impact on aggregate demand and also contribute to the price stability objective if they are aligned with monetary policy, lending credibility to the general macroeconomic framework.
“Thus, by reining in spending, governments can help monetary policy curb inflation at lower costs to the broader economy,” the Fund notes.
In this sense, the IMF believes that a targeted fiscal adjustment, which implies difficult political decisions about which budget items to cut and which to protect or expand, can reduce inflation at a lower cost for aggregate consumption and income inequality, while protects low-income families.
However, Gaspar and his team caution that, to safeguard the poor, who benefit most from public services, “tax increases or lower-priority spending cuts must be combined with larger transfers.”
“This strategy results, by design, in no decline in consumption by the poor, as well as in less decline in overall consumption,” he notes.