Working Paper: CEPR ID: DP17826
Authors: Michele Andreolli; Helene Rey
Abstract: The European Central Bank is unique in setting monetary policy for several sovereign states with heterogeneous debt levels and different maturity structures. The monetary-fiscal nexus is central to the functioning of the euro area. We focus on one particular aspect of that nexus, the effect of the reliability of the European Central Bank monetary policy on public finances. We show that when the ECB misses its inflation target this has large heterogeneous fiscal consequences for Euro Area countries. For comparison we estimate the fiscal consequences of persistent misses of their inflation target by the US Federal Reserve and the Bank of England: they are also large.
Keywords: Inflation Expectations; Inflation Target; Fiscal Costs
JEL Codes: E31; E44; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB inflation target misses (E52) | higher fiscal costs for countries with long-duration public debt (H69) |
| long-duration public debt (H63) | increased service charges (G29) |
| ECB inflation target misses (E52) | mispricing effect due to ECB's credibility issues (F31) |
| mispricing effect due to ECB's credibility issues + long-duration public debt (E49) | higher fiscal costs (H39) |
| inflation expectations + public debt duration (E62) | resulting fiscal impacts (H39) |