Fiscal Policy Shocks and Inflation in Russia

Abstract

The article evaluates the impact of fiscal policy shocks on inflation in the Russian economy using updated econometric methods. Although a SVAR model with Cholesky decomposition would commonly be employed for this kind of analysis, it had to be replaced by more current models because its excessively narrow assumptions made it unsuitable for this article. Fiscal impulse indicators based on IMF methodology were constructed and applied in a proxy-SVAR approach, as well as in a local projections method with instrumental variables (LP-IV), in order to assess the impact of fiscal policy shocks on inflation in the Russian economy from 2012 to 2024. The structural budget deficits establish that the peak of fiscal stimulus following the start of the Special Military Operation occurred in mid2023 and that fiscal policy had returned to a neutral stance by mid-2024. The most restrictive fiscal policy during the past fifteen years came in mid-2019. The proxy-SVAR and LP-IV methods indicate that fiscal policy shocks affect inflation for the next 4 to 6 quarters and that an abrupt change in fiscal policy by 1% of GDP produces a median change in inflation of 0.9–1.3% after a year. The key recommendation for returning inflation to its target value is normalization of fiscal policy. This requires reducing the level of government expenditures to 34.5-35.0% of GDP and strictly adhering to that fiscal rule when devising the federal budget.