Littérature scientifique sur le sujet « Fiscal policy. Risk sharing. European union »

We discuss the main fiscal policy issues in Europe, focusing on two that are at the core of the current debate. The first is that the government deficit and debt were, from the outset, the key objects of contention in the debate that led to the creation of the Eurozone, and they still are. The second issue is that a currency union implies the loss of a country-specific instrument, a national monetary policy. This puts a higher burden on fiscal policy as a tool to counteract shocks, a burden that might be even heavier now that the European Central Bank has arguably reached the Zero Lower Bound. Two obvious solutions are mutual insurance (or risk-sharing) amongst countries and a centralized stabilization policy. Yet both have been remarkably difficult to come by, especially due to political constraints. We review and discuss the relative merits of several proposals for increased insurance or centralization, or both. We conclude with an early discussion of the implications of the COVID-19 crisis for European fiscal policy reform and an assessment of the current fiscal measures.

This paper examines the European Union’s strategy of governing the economy through financial markets by focusing on the largely unacknowledged role of public development banks, including the multilateral European Investment Bank. It argues that these state-owned financial institutions have moved into a key position in the recent evolution of the European financial system and economic governance. Since the crisis, policy makers have used them to address the intrinsic volatility and excess liquidity of contemporary financial markets, as well as offset the constraints on public investment imposed by institutionalized fiscal austerity. The paper provides evidence for this claim through an analysis of the emergent policy nexus between the Investment Plan for Europe and the Action Plan on Building a Capital Markets Union. Based on official documents and interview data, it specifically traces the risk-sharing devices for small- and medium-sized enterprise and infrastructure finance set up by development banks within these initiatives. Equipped with public guarantees, they have been instrumental for the promotion of securitization markets and public–private partnerships through increased multilevel collaborations among development banks. The anchor role of such quasi-fiscal state actors in shaping capital markets, the paper concludes, has profound political implications, and therefore warrants further scholarly attention.

After its illegal occupation and annexation of Crimea in 2014 and continued military support for separatists in the Donbas, Russia escalated its war against Ukraine in February 2022 with direct ground attacks by Russian military forces on Ukraine's eastern, northern and southern borders, a blockade of Ukraine's coast and aerial attacks throughout the country. Millions of Ukrainians fled, including thousands of international students residing in Ukraine. Countries around the world responded to the resulting refugee crisis with varying policies. Many of Ukraine's neighboring countries enacted model immigration laws and developed various support schemes. Some governments, such as in Poland and the European Union (EU), immediately granted Ukrainian refugees the right to live, work, obtain access to education and receive benefits comparable to those to which their own citizens are entitled and created a generous and protective immigration model that attempts to prevent human trafficking and other forms of exploitation. Other countries geographically removed from the conflict used different models, including some with a private sponsorship component that, despite the best of intentions, may in retrospect be exposing refugees to the dangers of human trafficking and exploitation.<br/> Ukrainian refugees – also referred to as internally displaced persons (IDPs) if still remaining in Ukraine or as parolees if attempting to enter the United States (US) – seeking entry into the United Kingdom (UK) or US are required to find a private sponsor who accepts financial responsibility for them during their stay in their host country. In the UK, private sponsors are paid a monthly stipend, while in the US, private sponsors are not paid but actually contract with the US government to be financially responsible for the persons whom they are sponsoring. By contrast, Ukraine's neighbors, including Poland, with notably less economic and fiscal resources than either the UK or the US, have no private sponsorship requirement.<br/> Since the collapse of the Soviet Union in 1991, Ukrainians have been a vulnerable population subjected to human trafficking – a situation exacerbated by Russia's current war against their country. In the first weeks of the war, credible firsthand and in-real-time reports by Ukrainian- and Russian-speaking attorneys and human rights advocates quickly emerged that describe Ukrainian women refugees utilizing online dating platforms, social media sites and online chat rooms to find private sponsors in the UK and the US. While this government policy requiring private sponsorship appeared to be a prudent means for vetting refugees, burden-sharing and shifting the hosting costs away from taxpayers and governments' ledgers, the policy has unintended consequences. Refugee and human trafficking experts state that the private sponsorship requirement compels Ukrainian refugees, 90-plus percent of whom are women and children, to 'market' themselves – often online – to potential private sponsors in the UK and US, thereby exposing themselves to human traffickers. This policy has potentially – albeit unintentionally – increased, exacerbated and even facilitated the human trafficking of Ukrainian refugees, an already vulnerable population experiencing a precariously heightened risk for physical, sexual and economic exploitation due to their growing desperation for physical safety.<br/> This article, written from the practitioners' perspective, discusses how the private sponsorship requirement for Ukrainian refugees is potentially increasing the risk of human trafficking for an already at-risk population, unnecessarily jeopardizing their safety and further stripping them of their human dignity. The unintended consequences of private sponsorship demonstrate that such a requirement in a wartime scenario is ill-conceived, inappropriate and dangerous public policy and, dare it be said, potentially exploitative.

Governments in Europe responded to the COVID-19 pandemic by expanding their welfare systems to protect health, jobs, and incomes. The varied initiatives embody the principle of solidarity and demonstrate how welfare programs serve as a form of collective insurance against risk. But the twin health and economic crises also exposed gaps in coverage for many, including migrants and gig economy workers. Fiscal austerity, enforced by the European Union, has long constrained efforts to close those gaps.

Over the past two decades, international bond markets have become the chief disciplinarian of fiscal policy, displacing the International Monetary Fund and the European Union in this role. This trend culminated in the wake of the global financial crisis, as countries that had indulged in moral hazard and fiscal profligacy during the Great Moderation were vulnerable to a sharp rise in sovereign risk premium and in some cases to loss of market access. The article compares the response of new governments in Hungary and United Kingdom to restore policy credibility. A major lesson is that governments that adopt a rules-based fiscal framework, including fiscal watchdogs and transparency norms, are far more successful in anchoring fiscal expectations and in achieving fiscal sovereignty than those that do not.

The aim of the article is to identify the main components of government overall liabilities based on the Fiscal Risk Matrix classification introduced by the World Bank in 1999, and to estimate the amount and structure of these liabilities in European Union countries (EU Fiscal Risk Matrix). The climate liabilities definition and methodology included in the EU Fiscal Risk Matrix is also a novelty of the research. The study covered EU member states in the period 2018–2019, taking into account available data from the Eurostat database. On this basis, the EU Fiscal Risk Matrix was developed with the estimated structure of the burden of government liabilities for individual countries and the EU as a whole. The article used statistical and comparative analysis. The major conclusion of our research involves the proposal to implement a unified European methodology of government overall liabilities classification based on the EU Fiscal Risk Matrix to assess the fiscal debt burden and transparency of fiscal policy.

The aim of the article is to identify the main components of government overall liabilities based on the Fiscal Risk Matrix classification introduced by the World Bank in 1999, and to estimate the amount and structure of these liabilities in European Union countries (EU Fiscal Risk Matrix). The climate liabilities definition and methodology included in the EU Fiscal Risk Matrix is also a novelty of the research. The study covered EU member states in the period 2018–2019, taking into account available data from the Eurostat database. On this basis, the EU Fiscal Risk Matrix was developed with the estimated structure of the burden of government liabilities for individual countries and the EU as a whole. The article used statistical and comparative analysis. The major conclusion of our research involves the proposal to implement a unified European methodology of government overall liabilities classification based on the EU Fiscal Risk Matrix to assess the fiscal debt burden and transparency of fiscal policy.

AbstractWhat is the impact of Greece's fiscal meltdown on the effectiveness of Europe's response? Using Perrow's normal accidents theory, I argue that efforts to reduce the likelihood of a Greek default activated conflicting centripetal and centrifugal modes of governance. Greater centralisation in decision-making at the European Union level improves policy effectiveness because it addresses problems of contagion but it simultaneously raises the risk of overall failure by increasing diagnosis, coordination and compliance costs. Three episodes are explored: the first bailout in May 2010, the mid-term fiscal strategy in June–July 2011 and the second bailout in February 2012. Implications are drawn for theories of delegation, intergovernmentalism and the future of EU crisis management.

This paper aims at studying the legal aspects of the European Union (EU)’s fiscal policy, analyzing the statute of fiscal responsibility legal framework, the different measures undertaken in the last years with respect to European trends in fiscal governance and their implications for challenges in public finance sustainability. The research started from the presupposition that there is a lack of mechanisms capable of enforcing the area of public finance sustainability, and the implication of the events that created the economic conjuncture of recent years reveals that the solidity of public finances has reached an impasse and needs to be enhanced. The analyzed documents from the area of fiscal responsibility show formal respect for the legislative framework aimed at consolidating public finance sustainability and accentuate the need to use fiscal laws, independent institutions and mechanisms that put constraints on policymakers and determine them to spend more efficiently, invest more wisely, and obtain better results regarding public finance sustainability. We conclude that future policymaking processes need to consider the consolidation of independent fiscal institutions founded by Fiscal Responsibility Law framework, completed by fiscal rules and, therefore, need to redesign the fiscal risk management process.

Purpose Recent empirical studies by Antonakakis, Chatziantoniou and Filis (2013), Brogaard and Detzel (2015) and Christou et al. (2017) present evidence, which supports the notion that a rise in economic policy uncertainty (EPU) will lead to a decline in stock prices. The purpose of this paper is to examine US categorical policy uncertainty on stock returns while controlling for implied volatility and downside risk. In addition to the domestic impacts of policy uncertainty, this paper also presents evidence that changes in US policy uncertainty promptly propagates to the global stock markets. Design/methodology/approach This study uses a GED-GARCH (1, 1) model to estimate changes of uncertainties in US monetary, fiscal and trade policies on stock returns for the sample period of January 1990–December 2018. Robustness test is conducted by using different set of data and modeling techniques. Findings This paper contributes to the literature in several aspects. First, testing of US aggregate data while controlling for downside risk and implied volatility, consistently, shows that responses of stock prices to US policy uncertainty changes, not only display a negative effect in the current period but also have at least a one-month time-lag. The evidence supports the uncertainty premium hypothesis. Second, extending the test to global data reveals that US policy uncertainty changes have a negative impact on markets in Europe, China and Japan. Third, testing the data in sectoral stock markets mainly displays statistically significant results with a negative sign. Fourth, the evidence consistently shows that changes in policy uncertainty present an inverse relation to the stock returns, regardless of whether uncertainty is moving upward or downward. Research limitations/implications The current research is limited to the markets in the USA, eurozone, China and Japan. This study can be extended to additional countries, such as emerging markets. Practical implications This paper provides a model that uses categorical policy uncertainty approach to explain stock price changes. The parametric estimates provide insightful information in advising investors for making portfolio decision. Social implications The estimated coefficients of changes in monetary policy uncertainty, fiscal policy uncertainty and trade policy uncertainty are informative in assisting policymakers to formulate effective financial policies. Originality/value This study extends the existing risk premium model in several directions. First, it separates the financial risk factors from the EPU innovations; second, instead of using EPU, this study investigates the effects from monetary policy, fiscal policy and trade policy uncertainties; third, in additional to an examination of the effects of US categorical policy uncertainties on its own markets, this study also investigates the spillover effects to global major markets; fourth, besides the aggregate stock markets, this study estimates the effects of US policy uncertainty innovations on the sectoral stock returns.

The recent crisis has shed light on the weaknesses and the drawbacks of the European Monetary Union. In particular, many economists and commentators have suggested the need to complement the existing common monetary policy and stability pacts with some kind of fiscal union, i.e., enhanced supranational fiscal space and coordination, as a way to limit the impacts of idiosyncratic shocks and provide more risk sharing. The economic literature has proposed many solutions along this line, such as the institution of a European Minister of Finance, a central fiscal authority, Eurobonds, or a coordinated scheme of unemployment insurance. More specifically, the notion of fiscal union may imply the development of European revenue sources for the EMU budget, the harmonization of taxation within the EMU, a mechanism to increase fiscal discipline at both the union and national levels, building up a union-wide insurance mechanism against financial turbulence, including debt mutualization. Examples of these proposals are Ubide (2015) and Corsetti et al. (2015) which propose Stability Bonds that would give proceeds to member states and could be used to enact counter-cyclical fiscal policies in the Euro Area. Sapir and Wolff (2015) recommend the creation of a Eurosystem of Fiscal Policy (EFP) with two goals: fiscal debt sustainability and an adequate area-wide fiscal position. Guiso and Morelli (2014) propose the creation of a European Federal Institute to which member states would transfer part of their budget, equal to some agreed-upon share of the value of the EFI’s accumulated debt. Further, Clayes et al. (2014) claim that the EMU should adopt a common system of partially centralized unemployment benefits, coming from the need for counter-cyclical horizontal transfers, which should act as mutual insurance. Moreover, the European Commission (2012) advances the idea of building a centralized Eurozone fund which would provide member states with automatic but temporary fiscal transfers in the case of adverse idiosyncratic shocks (repaid in good times). Many of these proposals are on the table with the goal of reinforcing the overall EU governance. In this work we address two fundamental issues concerning the general Euro Zone architecture and its prospect. One relates to the implementation of a common EMU fiscal policy, its ability to stimulate growth during periods of downturns and to smooth out the effects of adverse shocks, reacting to them at business cycle frequency (aggregate demand management and fiscal multipliers). The other regards shock absorption across state borders and the strengthening of financial markets’ integration (private risk-sharing) and national governments’ intervention into credit markets or supranational institutions arrangements (public risk-sharing). What comes to light is that a unique European fiscal policy may not be as beneficial as it is often claimed, because the fiscal transmission mechanisms are quite different across member states. Indeed, in the first paper of this thesis we show that fiscal multipliers are different across EMU countries (the analysis concerns Belgium, France, Germany, Italy and Spain). The study detects instability in the magnitude of the multipliers and in the slopes of the impulse response functions, both across countries and times, using standard VARs and time varying parameter VARs (TVP-VAR). We claim that the differences are due to transmission mechanisms (in the paper they are captured by the beta coefficients of the TVP-VAR) and driving forces rather than the magnitude and the volatility of national fiscal shocks per se (in the paper they are captured by the standard deviations of the TVP-VAR residuals). We argue that the observed degree of heterogeneity in the fiscal multipliers and in the other response coefficients across EMU countries casts some doubt on the real ability of EMU governments to coordinate their fiscal actions when needed and on the effectiveness of a common EMU fiscal policy in stimulating real economic activity. In the second paper of this dissertation, instead, we study the mechanisms, extent and characteristics of risk sharing across the EMU. How well do international financial markets allow for consumption smoothing in member countries facing idiosyncratic shocks? How effective are public national and supranational institutions in improving risk sharing? Our analysis extends the work and methodology pioneered by Asdrubali et al (1996) by updating results up to 2014 and by identifying the role of the European institutions (like the European Financial Stability Facility (ESFS) or the European Stabilization Mechanism (ESM)) created right after the great recession with the objective of assisting countries with limited market access. As a matter of fact, we find that the role played by public official transfers from these institutions to more vulnerable countries in order to smooth consumption during the great depression is noteworthy: the ESFS and the ESM have increased the amount of risk sharing within the EMU. More specifically, we use the method of variance decomposition first implemented by Asdrubali et al (1996) to identify the main channels of risk sharing (net factor income, international transfers and credit markets) and we split the credit market channel into two parts: smoothing achieved through private institutions (markets) and the public sector (national governments and official European institutions). We find that the European institutions have largely compensated the reduced role of national governments during the recent financial crisis. Based on these contributions, we derive some fiscal policy suggestions and conclusions. First, we think that there are reasons to be skeptical about the effectiveness and feasibility of a common fiscal policy for the purpose of stabilizing the business cycle. The reasons are that the fiscal transmission mechanisms are different among countries; countries need their own fiscal counter-cyclical measures in order to absorb idiosyncratic shocks, and, last but not least, European countries are not ready and willing to give up their sovereignty. Secondly, we suggest another type of coordination for EMU fiscal governance that is based on sharing resources at central level, through well-functioning and participated European institutions (along the lines of the ESM), that provide transfers to countries in exceptional circumstances and during period of downturns.

Many people have already questioned whether Greece would default: investors, economists, politicians and general public. The Greek debt crisis has also caused a great turmoil in the EU causing fears of its spreading to other countries with poor fiscal situation in Eurozone through bond markets. Finally the rescue package was prepared for Greece consisting of EUR 110 billion loan facility from both Eurozone and IMF. We study the Greek fiscal crisis in the thesis. We try to find its real causes in the historical chapter and we also show the methodology which can be used to assess the credit risk of Greek government using bond market information and CDS contracts information. In the empirical part we study the evolution of the probability of default of Greek government during the debt crisis using parsimonious model based on the bond market information.

AbstractIn the wake of the “Great Recession” and its severe fiscal implications, many European countries enacted significant pension reforms aimed at reducing public spending and limiting contribution rates. Unlike most changes carried out before, they were implemented swiftly and without building a broad political and social consensus, usually being suggested or even mandated by inter- and supranational organisations such as the International Monetary Fund (IMF) or the European Union (EU). While some of these cuts were at least partly revoked during the following years of economic recovery, European welfare states still tend to face lower “pension burdens” in the upcoming decades than had been expected during the 2000s. Financial sustainability, however, puts adequacy at risk for present and future retirees, many of whom no longer achieve sufficient working careers anyway.

AbstractIn this part of the book, we discuss proposals to improve architectural and crisis management lacunas. While other partners of the network present own proposals, this chapter has the objective to sketch out proposals, which have been discussed or are still in the pipeline at the top level of European Union (EU) decision-takers and institutions to remedy lacunas, errors and omissions of the Economic and Monetary Union (EMU) architecture. A main argument advanced is that the reforms with a focus on “risk-avoidance” and stronger “surveillance” and “monitoring” had more success, while any reforms based on the principle of “risk-sharing have encountered major resistance, both for the financial market regulation and for the fiscal framework.

This chapter focuses on the European Investment Bank and the Juncker Plan in terms of its impact on industrial policy and state-market relations. Showing the growth of both the EIB and the EIF over the past two decades, the chapter highlights the increasing importance of engaging private investors in their financial operations. By proposing an analytical distinction between “economic” and “financial” risk, it argues that operating on risk-sharing arrangements has led the EIB—and the Juncker Plan—to effectively accumulate the latter at the expense of the former, which has resulted not only in a trade-off between actual policy steer as envisaged by the Commission and increased leverage as a developmental strategy, but also in political tensions within the field of development banking.

This chapter analyses the implications of Brexit for the UK and the issues facing the EU without the UK. It assesses the costs to the UK in terms of economics and loss of influence on decisions affecting key UK interests. It concludes that the UK is bound to be diminished, but that the EU will also feel the loss of UK influence on economic liberalization, in overseas aid and in foreign policy. The Eurozone will survive but its difficulty in making progress towards a fiscal union will also make it harder for a core grouping to emerge. In seeking to set a common vision for the EU, President Macron of France is so far a lonely voice. For the author, the EU offers a means of managing the relations between potentially querulous neighbours and of entrenching and sharing democratic values. There will be tangible, and less immediately obvious, losses to the UK.

Payments from non-recyclable plastic packaging waste – a new source of budgetary revenue of the European Union. Purpose: To present the construction of a new source of EU budget revenues (contributions from non-recyclable plastic packaging waste) and its assessment against the EU’s own resources system from the point of view of the set criteria. Design/methodology/approach: The study is of a literature and empirical character. The research consists of four stages. The first stage presents the evolution of the EU’s own resources in the period 1951–2020. Domestic literature and EU source documents in Polish and English were used. In the second stage, the construction of a new source of revenue was presented. The legal regulations of the EU were used. The third stage is the presentation of the proposed burden-sharing for the new resource between Member States in 2022. For this purpose, internal regulations and EU statistical data was used. In the final stage of the research, the new source of revenue was assessed against other own resources according to the criteria set (simple structure, transparency, fiscal stability and efficiency, link with the EU policy, low collection costs, fair burden sharing, financial autonomy). EU source material was used for this. The study mainly uses the method of descriptive analysis, and for the assessment of own resources—also the method of qualitative multi-criteria analysis. Findings: The analysis shows that the new source of revenue is primarily characterized by a simple structure, low collection costs, is also closely related to the EU environmental policy, and ensures a relatively fair burden-sharing between the Member States. On the other hand, the weaknesses of the new source are poor transparency and poor fiscal efficiency. As a result, it provides the Union with little financial independence. The new source of revenue generally improves the quality of the entire system of UE own resources.

The Eurozone has been said to have caught a disease called “secular stagnation”. The engineering of a powerful investment drive seems the only way out of this self-fulfilling low-growth trap. The European Union has already set investment objectives in the Climate and Energy Package, related to four key sectors. Several financing tools need to be combined to tailor risk-sharing devices for investments in each sector. This can be achieved through a two-tier approach. First, for the four key sectors, a high notional carbon price is used to set an asset value on the carbon saved by new investments (“carbon asset”): these assets are accepted as repayment by central banks, and publically guaranteed. The ECB, by buying financial instruments issued by the low-carbon investors, creates a direct transmission channel to these areas of the economy. Second, fiscal measures ensure the carbon price catches up with the notional value, thus generating revenues that allow for the purchase of the carbon debt held by the central banks, guaranteeing the final budget neutrality of the process.

In the world, the question of the good practice to manage of territory is a pillar of the implementations of Sustainable Development Goals 2015-2030. The authors are working in collaboration with a holistic approach at the topic. In this way, the Smart Communities and Smart Territories are the new paradigms in 21th Century to solve the question of the adaptation at the Climate Change and to guarantee, for the future generation, the conservation and promotion of all potentialities of each territory and identity of areas. Until now, they have use a deductive method to analyse and show, in the framework of the Sustainable Development, the Community Led Local Development (EU Programme for CLLD) and Ecosystem Services, the need to move from an emergency management approach to pre-emptive territory management. The results of this research have produced the original and autonomous configuration of a new and innovative strategy and governance based on a model that puts in synergy the three aspects of the framework that has been given the name of Territorial Management Contracts (TMC). The TMC, appear a possible shared and democratic model that could to combine the territory risk management with solutions of development driving and sharing by the local populations. This innovative approach is strictly linked with the targets of the Sustainable Development Goals 2015-2030 and the Europe 2020 (smart, sustainable and inclusive). The authors argue that the TMC model is now sufficiently mature to pass from the processing phase to that of the implementation that in the Payment of the Ecosystem Services (PES) finds a concrete reinforcement of the scientific analysis carried out.

Open banking – promoted in the European Union by the access to account rule contained in the Directive (EU) 2015/2366 on payment services in the internal market (PSD2) – is supposed to enhance consumer’s welfare and to foster competition. However, many observers are fearful about the negative effects of the entry into the market of the so-called BigTech giants. Unless incumbent banks are able to rise above the technological challenges, the risk is that, in the long run, BigTech firms could dominate the market, by virtue of their great ability to collect data on consumer preferences, and to process them with sophisticated tools, such as Artificial Intelligence and Machine Learning techniques; not to mention the possible benefits arising from the cross-subsidisation. This paper aims at analysing the controversial relationship between open banking and competition. In this framework, many aspects must be clarified, such as the definition of the relevant markets; the identification of the dominant entities; the relationship with the essential facility doctrine. The specific competition problems encountered in the financial sector need to be inscribed in the context of the more general debate around access to data in the digital sphere. The evolving scenario poses a serious challenge to regulators, calling them to strike the right balance between fostering innovation and preserving financial stability. The appraisal intends not only to cover EU law and policy, but also to make a comparison with other legal systems. In this respect, something noteworthy is taking place in the United States where, as of today, consumers’ access to financial data sharing has been largely dependent on private-sector efforts. Indeed, Section 1033 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (passed in the aftermath of the financial crisis of 2008) provides that, subject to rules prescribed by the Bureau of Consumer Financial Protection (CFPB), a consumer financial services provider must make available to a consumer information, in its control or possession, concerning the consumer financial product or service that the consumer obtained from the provider. This provision, which dates back to 2010, has never been implemented. However, on 22 October 2020, the CFBP has announced its intention to regulate open banking, issuing an advanced notice of proposed rulemaking. In light of their investigation, the authors advocate the adaptation of the current strategies to the modified conditions and, in some instances, the creation of novel mechanisms, more suitable to face unprecedented threats.

In the second quarter, annual inflation (9.67%), the technical staff’s projections and its expectations continued to increase, remaining above the target. International cost shocks, accentuated by Russia's invasion of Ukraine, have been more persistent than projected, thus contributing to higher inflation. The effects of indexation, higher than estimated excess demand, a tighter labor market, inflation expectations that continue to rise and currently exceed 3%, and the exchange rate pressures add to those described above. High core inflation measures as well as in the producer price index (PPI) across all baskets confirm a significant spread in price increases. Compared to estimates presented in April, the new forecast trajectory for headline and core inflation increased. This was partly the result of greater exchange rate pressure on prices, and a larger output gap, which is expected to remain positive for the remainder of 2022 and which is estimated to close towards yearend 2023. In addition, these trends take into account higher inflation rate indexation, more persistent above-target inflation expectations, a quickening of domestic fuel price increases due to the correction of lags versus the parity price and higher international oil price forecasts. The forecast supposes a good domestic supply of perishable foods, although it also considers that international prices of processed foods will remain high. In terms of the goods sub-basket, the end of the national health emergency implies a reversal of the value-added tax (VAT) refund applied to health and personal hygiene products, resulting in increases in the prices of these goods. Alternatively, the monetary policy adjustment process and the moderation of external shocks would help inflation and its expectations to begin to decrease over time and resume their alignment with the target. Thus, the new projection suggests that inflation could remain high for the second half of 2022, closing at 9.7%. However, it would begin to fall during 2023, closing the year at 5.7%. These forecasts are subject to significant uncertainty, especially regarding the future behavior of external cost shocks, the degree of indexation of nominal contracts and decisions made regarding the domestic price of fuels. Economic activity continues to outperform expectations, and the technical staff’s growth projections for 2022 have been revised upwards from 5% to 6.9%. The new forecasts suggest higher output levels that would continue to exceed the economy’s productive capacity for the remainder of 2022. Economic growth during the first quarter was above that estimated in April, while economic activity indicators for the second quarter suggest that the GDP could be expected to remain high, potentially above that of the first quarter. Domestic demand is expected to maintain a positive dynamic, in particular, due to the household consumption quarterly growth, as suggested by vehicle registrations, retail sales, credit card purchases and consumer loan disbursement figures. A slowdown in the machinery and equipment imports from the levels observed in March contrasts with the positive performance of sales and housing construction licenses, which indicates an investment level similar to that registered for the first three months of the year. International trade data suggests the trade deficit would be reduced as a consequence of import levels that would be lesser than those observed in the first quarter, and stable export levels. For the remainder of the year and 2023, a deceleration in consumption is expected from the high levels seen during the first half of the year, partially as a result of lower repressed demand, tighter domestic financial conditions and household available income deterioration due to increased inflation. Investment is expected to continue its slow recovery while remaining below pre-pandemic levels. The trade deficit is expected to tighten due to projected lower domestic demand dynamics, and high prices of oil and other basic goods exported by the country. Given the above, economic growth in the second quarter of 2022 would be 11.5%, and for 2022 and 2023 an annual growth of 6.9% and 1.1% is expected, respectively. Currently, and for the remainder of 2022, the output gap would be positive and greater than that estimated in April, and prices would be affected by demand pressures. These projections continue to be affected by significant uncertainty associated with global political tensions, the expected adjustment of monetary policy in developed countries, external demand behavior, changes in country risk outlook, and the future developments in domestic fiscal policy, among others. The high inflation levels and respective expectations, which exceed the target of the world's main central banks, largely explain the observed and anticipated increase in their monetary policy interest rates. This environment has tempered the growth forecast for external demand. Disruptions in value chains, rising international food and energy prices, and expansionary monetary and fiscal policies have contributed to the rise in inflation and above-target expectations seen by several of Colombia’s main trading partners. These cost and price shocks, heightened by the effects of Russia's invasion of Ukraine, have been more prevalent than expected and have taken place within a set of output and employment recovery, variables that in some countries currently equal or exceed their projected long-term levels. In response, the U.S. Federal Reserve accelerated the pace of the benchmark interest rate increase and rapidly reduced liquidity levels in the money market. Financial market actors expect this behavior to continue and, consequently, significantly increase their expectations of the average path of the Fed's benchmark interest rate. In this setting, the U.S. dollar appreciated versus the peso in the second quarter and emerging market risk measures increased, a behavior that intensified for Colombia. Given the aforementioned, for the remainder of 2022 and 2023, the Bank's technical staff increased the forecast trajectory for the Fed's interest rate and reduced the country's external demand growth forecast. The projected oil price was revised upward over the forecast horizon, specifically due to greater supply restrictions and the interruption of hydrocarbon trade between the European Union and Russia. Global geopolitical tensions, a tightening of monetary policy in developed economies, the increase in risk perception for emerging markets and the macroeconomic imbalances in the country explain the increase in the projected trajectory of the risk premium, its trend level and the neutral real interest rate1. Uncertainty about external forecasts and their consequent impact on the country's macroeconomic scenario remains high, given the unpredictable evolution of the conflict between Russia and Ukraine, geopolitical tensions, the degree of the global economic slowdown and the effect the response to recent outbreaks of the pandemic in some Asian countries may have on the world economy. This macroeconomic scenario that includes high inflation, inflation forecasts, and expectations above 3% and a positive output gap suggests the need for a contractionary monetary policy that mitigates the risk of the persistent unanchoring of inflation expectations. In contrast to the forecasts of the April report, the increase in the risk premium trend implies a higher neutral real interest rate and a greater prevailing monetary stimulus than previously estimated. For its part, domestic demand has been more dynamic, with a higher observed and expected output level that exceeds the economy’s productive capacity. The surprising accelerations in the headline and core inflation reflect stronger and more persistent external shocks, which, in combination with the strength of aggregate demand, indexation, higher inflation expectations and exchange rate pressures, explain the upward projected inflation trajectory at levels that exceed the target over the next two years. This is corroborated by the inflation expectations of economic analysts and those derived from the public debt market, which continued to climb and currently exceed 3%. All of the above increase the risk of unanchoring inflation expectations and could generate widespread indexation processes that may push inflation away from the target for longer. This new macroeconomic scenario suggests that the interest rate adjustment should continue towards a contractionary monetary policy landscape. 1.2. Monetary policy decision Banco de la República’s Board of Directors (BDBR), at its meetings in June and July 2022, decided to continue adjusting its monetary policy. At its June meeting, the BDBR decided to increase the monetary policy rate by 150 basis points (b.p.) and its July meeting by majority vote, on a 150 b.p. increase thereof at its July meeting. Consequently, the monetary policy interest rate currently stands at 9.0% . 1 The neutral real interest rate refers to the real interest rate level that is neither stimulative nor contractionary for aggregate demand and, therefore, does not generate pressures that lead to the close of the output gap. In a small, open economy like Colombia, this rate depends on the external neutral real interest rate, medium-term components of the country risk premium, and expected depreciation. Box 1: A Weekly Indicator of Economic Activity for Colombia Juan Pablo Cote Carlos Daniel Rojas Nicol Rodriguez Box 2: Common Inflationary Trends in Colombia Carlos D. Rojas-Martínez Nicolás Martínez-Cortés Franky Juliano Galeano-Ramírez Box 3: Shock Decomposition of 2021 Forecast Errors Nicolás Moreno Arias