Fiscal Arithmetic and the Global Inflation Outlook

Debt-financed fiscal policy is driving much of today’s high inflation, but as pandemic-era measures fade, central banks will likely return to their key role in managing price levels.

What is driving the stubbornly high inflation evident in most advanced and emerging economies?

The complete answer may depend on where you live. The war in Ukraine pushed energy inflation higher in Europe. Weaker currencies have contributed to higher goods inflation in Japan and the Nordics. And soaring agriculture prices have raised food prices in many regions, particularly emerging markets.

Fiscal Policy and government debt: key inflationary pressures

While the sources of inflation vary, debt-financed fiscal policy is a major driver in many regions. Much of this policy was debated and enacted rapidly in 2020 to directly support households and businesses during the COVID-19 pandemic. As this government-financed funding flowed into the economy, demand for goods and services rose significantly in the following years (in many cases amid supply constraints), and price levels rose.

In advanced economies, there’s a significant positive relationship between core inflation and sovereign debt growth since the start of the pandemic (see Figure 1). Different fiscal approaches among these countries likely contributed to the wide variation in their inflation trajectories (we also note there’s typically a lag between enacting policy and seeing its impact in the inflation data). On the one end, New Zealand, the U.K., and the U.S. have seen double-digit core inflation and high government debt growth. On the other end, Japan and Switzerland have seen much smaller increases in both government debt and core prices. The euro area lies in between.

The Post Pandemic Period Has Seen a Marked Correlation Between Fiscal Debt and Core Inflation Advanced Economies