Fiscal Policy, Disinflation, and the Safety Net

The Issue:

While inflation affects all people in an economy, its effects can be particularly harmful to poorer households. The standard approach to reducing inflation, by causing a recession through monetary tightening, can also disproportionately harm the poor. Fiscal policy can help monetary policy curb inflation, while at the same time supporting poor families.

The Facts:

• Inflation has uneven effects across different income and age groups and often leads to a rise in poverty.
• Fiscal policy can contribute to lowering inflation both by directly reducing aggregate demand and by making the disinflationary policy package more credible. 
• There is empirical evidence that reducing public spending helps to lower inflation. The recent IMF study finds that reducing public spending by one percentage point of GDP lowered inflation by 0.5 percentage points in a sample of 17 advanced countries starting in 1985.   
• Fiscal policy can also mitigate the unwelcome distributional costs of a disinflationary monetary policy that causes interest rates to spike. Cuts in lower-priority government spending combined with targeted transfers to lower-income families that have the net effect of reducing aggregate demand can support disinflation while at the same time protecting the poor.

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monetary
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interest rates
monetary policy