ECB Research Bulletin: Fiscal Policy Key to Diminishing Inflation Impact on Households

20 February 2024

By Isabel Teles – FRANKFURT (Econostream) – Fiscal policy played a central role in cushioning the blow to households of the 2021-22 inflation surge in different euro area countries, according to a research bulletin published Tuesday by the European Central Bank.

During the analysed period, there were ‘large average welfare losses, especially compared with commonly estimated costs of a typical recession, and substantial differences across countries’, which posed a challenge to monetary policy, according to the authors of the bulletin.

‘[T]his historical episode highlights the importance of fiscal policy in responding to country-specific dynamics within a monetary union, where monetary policy cannot be tailored to individual countries’, the authors said.

In this context, fiscal policy was fundamental to diminishing the effects of inflation, particularly in the most vulnerable households, the bulletin said, ‘and reduced by 2% of 2021-22 income the welfare losses caused by the inflation surge for the median household.’

The lag in wage and pensions adjustments was one of the driving factors of welfare losses, according to the authors, and while the welfare loss resulting from the slow adjustment of wages was temporary, the welfare loss on nominally denominated assets was permanent.

‘In 2021-22 nominal wages grew by less than 3% on average for most countries, age groups and consumption groups, which is much less than the respective average inflation rates over the period’, the bulletin said. ‘Pensions grew only slightly more than wages. This channel generated welfare losses amounting to 4% of 2021-22 income for the median household.’