A limited impact on inflation would have a single VAT reduction, and if the measure is accompanied by structural measures the inflation will be significant and sustainable.

This conclusion concludes a study by the Bank of Greece, which is published in the latest issue of the financial bulletin.

As economists, George Paleodimos and Dimitris Papageorgiou, pointed out, who prepared the study, “the effectiveness of a single, temporary reduction in VAT as a measure of limiting inflation in the Greek economy is significantly limited. On the contrary, there is significant and sustainable inflation to decline when the VAT reduction is accompanied by structural measures that boost competition in product and services markets and reduce distortions in the economy. In addition, permanent VAT reductions are more effective than temporary, as they enhance the credibility of economic policy and positively affect household and business expectations. “

The general conclusion of the study is that the reduction of VAT on its own is not sufficient as a tool for the decline of inflationary pressure on the Greek economy, as its effectiveness depends on the wider institutional and structural environment. Consequently, the exploitation of VAT as an effective measure of deflationary intervention presupposes its integration into a broader context of economic policy, which includes complementary structural interventions aimed at boosting competition in product and services markets and reducing distortions in the economy.

As it is found when VAT reductions are accompanied by policies that boost competition in the product market, deflationary effects become significant and sustainable. At the same time, the results from a dynamic thoughtful model show that the repentance of VAT reductions in consumer prices in the short term is partial and is estimated between 19% and 25%. The degree of passage is influenced by structural factors as well as the duration of the application of the measure.

Permanent VAT reductions almost double the passage in prices compared to temporary. Deflationary effects are also stronger in more competitive market economies, where businesses are more willing to pass on prices cost reductions. On the contrary, in economies characterized by a high degree of stiffness or limited use of domestic inputs, the effects on inflation from VAT reductions are weaker.

Overall, the findings of the study highlight the role of structural and institutional characteristics in the way VAT changes affect inflation.

It is recalled that the proposal for temporary and targeted reduction in value added tax (VAT) in certain categories of basic goods, such as food and energy, has returned to the forefront in recent years as a policy of policy against the wave of inflationary pressure and was adopted by several eurozone countries. These pressures derive mainly from the increase in the cost of energy and raw materials, as well as from the supply chain disturbances, mainly due to the war in Ukraine.