Inflation targeting in the context of fiscal stimulation

Objective: to analyze the current issues limiting the effectiveness of the traditional inflation targeting regime; to adjust the basic characteristics of this monetary regime which ensures price stability in order to increase the reliability of the central banks’ macroeconomic forecast.

Methods: the article uses empirical, statistical, logical, and comparative methods of economic analysis to study the specifics of the central banks’ inflation targeting regime in the context of stimulating fiscal policy.

Results: the article considers the basic characteristics of the traditional inflation targeting regime; identifies the disadvantages of the inflation targeting regime; and reviews the scientific literature on the inflation targeting regime functioning within the monetary and fiscal dominance. The main postulates of the fiscal theory of price regulation are identified. A number of recommendatory measures to adjust the current inflation targeting regime are proposed for the Bank of Russia.

Scientific novelty: the author showed that raising the key rate without changing the fiscal components in monetary policy cannot reduce inflation even in the short term. Rational expectations and monetary policy, analyzed in the framework of fiscal theory, do not reduce inflation without fiscal support. In countries with inflation targeting, high interest rates can increase risks of servicing public debt and lead to increased budget deficits. The government’s fiscal policy may create fiscal inflation that the central bank will be unable to control and regulate. Given the rapid growth of public debt and budget deficits in the leading countries, it is likely that fiscal inflation will become the main component of a sustained increase in global inflation in the future. If the sovereign debt is denominated in local currency, the borrowing country will be exposed to currency risk, which is transferred by international investors or Russia’s trading partners to debt obligations in Russian currency.

Practical significance: the main provisions and conclusions can be used: to regulate interest rate policy (real interest rates), create and accumulate “buffers” of primary surplus related to the costs of attracting and servicing public debt; to develop a mechanism for redistributing real payments differentiated by the maturity of public debt; under the growing fiscal imbalances, government debt can be reduced by increasing inflation and using primary surpluses; during 2022–2024, the monetary policy of the Bank of Russia operates within a fiscal dominance regime, as evidenced by the basic fiscal components missing from the macroeconomic forecast; the fiscal components (such as the size of the budget surplus linked to the yield of public sector bonds, the size of government debt and the amount of budget allocations allocated to the Bank of Russia’s Quarterly Forecast Model) should be included in the budget block of the Bank of Russia to repay the debt, which will make it possible to revise the expected inflation forecast, taking into account fiscal inflation.

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