How Can Fiscal Policy Tackle Stagflation?

Economic policy generally has many objectives. To increase income and employment, to keep prices stable, to ensure the sustainability of public finances, to provide adequate liquidity conditions and so on. Usually these goals relate to reactions to economic disturbances, such as an economic crisis, a pandemic, a war, or anything that threatens the financial well-being of a state and must be addressed in one way or another.

If we limit the discussion to the national context of a member state or state, in terms of the economic policy that within the eurozone or a federal state, this economic policy concerns fiscal policy and given that the Central Bank is either the ECB or the Fed etc, determines the monetary policy which is considered exogenous.

During the pandemic, the main goal was to contain the recession and protect households and businesses from the economic consequences of restrictive measures, which led to a sharp deterioration in public finances. In short, in both economic policy and private economic choices, there are dilemmas, or trade-offs as we usually call them, between what one wants to achieve and what one has to sacrifice in order to achieve it.

However, governments that are fully responsible for implementing fiscal policy look not only at the financial cost of their choices, but also at the political cost. In democracies, economic policy is pursued by elected representatives running for re-election, and their choices are based not only on the views of economists but also on those of pollsters who weigh the reactions of voters and communicators who seek ways to better articulate their views.

The dilemmas of fiscal policies

The influence of these two types of advisers depends on the phase of the political cycle. The closer we are to elections, the stronger the weight of the opinion of pollsters and communicators (the political cost) and the lower the weight of the opinion of economists (financial cost). The mediation of economic policy by the political system and the political situation of each country is a critical parameter both for its direction and for its effectiveness.

In the current period, economic policy is called upon to face a worrying international situation due to at least three factors:

1. First, is the rise in prices for energy and other commodities, such as food, which significantly affect the cost of producing businesses and the cost of living for households.

2. Second, is the rise in interest rates as central banks reduce liquidity in an effort to curb inflation by increasing public and private borrowing costs.

3. The third, is the escalation of geopolitical instability with a focus on the war in Ukraine and the rearrangement of international alliances and balances.

The combination of these three factors causes serious economic and political uncertainties for the next day that act as a deterrent to economic decisions and undermine economic activity.

In the face of these conditions, economic policy faces new dilemmas. On the one hand, it is called upon to protect households and businesses affected by price increases, and on the other hand, to stabilize the public finances that have deteriorated in the previous period. The first is linked to ensuring social cohesion, which is a fundamental obligation of the state to its citizens, and the second is to avoid a fiscal derailment.

The balance between the above two conflicting but equally important priorities highlights the redistributive dimension that characterizes any economic policy and turns a technical dilemma into a political one.

The cost and benefit of each option are not distributed proportionally among the citizens but, on the contrary, some gain or lose more or less than others. In particular, if the state has to financially support some citizens, without overburdening public finances, it will have to tax some other citizens. Most of the dilemmas of economic (fiscal) policy are summarized in dilemmas of redistribution of the tax burden among citizens.

How can stagnant inflation be tackled on the basis of fiscal policy alone?

The main concern of this day is to find the right resources, from the governments of the member countries and in general of all countries, that can support the purchasing power and consumption of households and businesses, which is affected by the continuous price increases, without at the same time creating fiscal derailment in the state (federal) budgets of the countries.

Raising taxes on certain high-income groups will help to find these resources, but usually the amount of revenue from this type of taxation is not enough to support society as a whole. Rather, they satisfy political choices, e.g. the government taxes the rich to help the poor income households etc.

The solution, in these cases, is a deep cut in public spending (excluding public spending on the welfare state), with the main focus being a drastic reduction in the size of the state and its services. In studies that have been done (please read the book entitled “A Development Plan for the Greek Economy & A New Strategy to Boost Growth in Eurozone“, Author: Athanassios Chonthrogiannis, www.amazon.com > In Amazon Search engine write either the full title or the full name of the Author), drastic reduction of public budget expenditures of the General or Federal budgets respectively of the Eurozone / EU member states and their maintenance at a maximum of 15% of the annual GDP of the member country, will be released funds that in total exceed 11.3 trillion euros. these funds will be able to be distributed to the respective societies of the member countries to support their incomes and consumption from the constant price increases.

Only in this case can we achieve in every member state of the European Union both the support of incomes and the consumption of low-income households in the face of rising inflation, as well as the support of businesses in terms of their production, but most importantly without creating a fiscal derailment in the general or federal budgets of EU member states

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Trust Economics is a specialized independent economic research, analysis and consultancy business. Our team provides ingenious analysis in the macro & micro economic field, in the field of financial market, regional and sectoral analysis equally, forecasts, consultancy, specialized studies-research/projects from its headquarters in Athens, Greece.

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