Fiscal policy in the CNB’s modelling system
The monitoring, assessment and anticipation of fiscal policy is an integral part of the decision-making on the optimal monetary policy settings. Each CNB forecast therefore contains an assumption regarding future fiscal policy. This can be expressed in many ways, for example, using the government sector deficit, government consumption expenditure, the fiscal stance or the fiscal impulse.
From the point of view of monetary policy it is crucial to capture the impact of fiscal policy on inflation. Fiscal policy is inputted into the CNB's prediction model as an expert-estimated residual in the output gap equation and subsequently affects inflation through the output gap (as the output gap in the CNB's model is a proxy for the demand-pull inflation pressures in the economy). In estimating the residuals, only those government revenues and expenditures which have an impact on domestic aggregate demand have to be taken into account. We then refer to the year-on-year change in the demand-relevant balance in percentage points of GDP derived from these revenues and expenditures, as the fiscal impulse.
If the fiscal impulse is positive, fiscal policy acts towards a more open positive (or more closed negative) output gap and towards higher inflation, and we speak of easy (expansionary) fiscal policy. Conversely, if the fiscal impulse is negative, fiscal policy has the opposite effect on the output gap and inflation, and we describe it as tight (restrictive). As the fiscal impulse expresses the year-on-year change in the demand-relevant balance, it can be negative (indicating restriction) even when the government deficit is strongly negative. This fact is illustrated in Chart 1 (Box), which compares the CNB's estimate of the fiscal impulse in 1999-2005 with the public budget deficit.
The calculation of the fiscal impulse does not take into consideration the phase of the business cycle and its implications for the assessment of fiscal policy, i.e. whether a fiscal policy that is viewed as expansive based on the estimate of the fiscal impulse is justifiable by a cyclical deterioration in the performance of the economy or vice versa. Information on how public sector finances changed year on year excluding the effect that the business cycle had on them is provided by an indicator called the fiscal stance. The fiscal stance is defined as the year-on-year change in the cyclically adjusted public finance balance. As with the fiscal impulse, we speak of tight, neutral or easy fiscal policy depending on the sign of the fiscal stance. Its value is not inputted into the CNB's modelling system, but does form part of the information supplied to the CNB Bank Board to support its decision-making (see Chart 2).