Working Paper: CEPR ID: DP16138
Authors: Lucrezia Reichlin; Giovanni Ricco; Matthieu Tarb
Abstract: We study the monetary-fiscal mix in the European Monetary Union. The medium and long-run effects of conventional and unconventional monetary policy can be analysed by combining monetary policy shocks identified in a Structural VAR, and the general government budget constraint featuring a single central bank and multiple fiscal authorities. In response to a conventional easing of the policy rate, the real discount rate declines, absorbing the increase in deficit due to the fiscal policy leaning towards the easing. Conversely, in response to an unconventional easing of the long end of the yield curve, the discount rate declines strongly, while the primary fiscal surplus barely moves. The long-run effect of unconventional monetary easing on inflation is about half than that of conventional, a result which also explains the muted response of fiscal policy. Results do not point to large differences across countries.
Keywords: monetary-fiscal interaction; fiscal policy; monetary policy; intertemporal government budget constraint
JEL Codes: E31; E63; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conventional monetary policy easing (E52) | decline in the real discount rate (E43) |
| conventional monetary policy easing (E52) | increase in the deficit due to fiscal policy easing (E62) |
| decline in the real discount rate (E43) | decrease in the primary fiscal surplus (H69) |
| unconventional monetary policy shock (E19) | significant decline in the discount rate (E43) |
| unconventional monetary policy shock (E19) | negligible movement in the primary fiscal surplus (H62) |
| unconventional monetary easing (E49) | long-run effect on inflation (E31) |
| conventional monetary easing (E52) | long-run effect on inflation (E31) |