Violating Fiscal Rules: Implications for Inflation, Expectations, and Monetary Credibility

Abstract

Abstract This study investigates the impact of actual and expected fiscal rule breaches on inflation, inflation expectations, and monetary policy credibility. Using Brazilian data from January 2003 to December 2024, the findings suggest that both observed and expected fiscal rule violations lead to higher inflation and inflation expectations, along with reduced monetary policy credibility. In addition, based on impulse response functions obtained through Local Projections, we show that fiscal rule breaches increase inflation under both high and low debt levels. However, the effects are more persistent under a high debt regime and relatively stronger under a low debt regime. Inflation expectations are also more persistently affected in a high debt regime.