Working Paper: NBER ID: w30819
Authors: Michele Andreolli; Hélène 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 the reliability of the European Central Bank's 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 also estimate the fiscal consequences of the Federal Reserve and the Bank of England missing their inflation targets. They are also sizeable.
Keywords: Inflation Targeting; Public Finances; Monetary Policy; Euro Area
JEL Codes: E31; E44; E52; E60; F45; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB misses its inflation target (E52) | large heterogeneous fiscal consequences for euro area countries (E62) |
| ECB misses its inflation target (E52) | higher service charges for countries with longer-duration debt (F34) |
| long-duration debt (H63) | higher service charges in a low interest rate environment (G21) |
| credibility of the central bank (E58) | pricing of long-term bonds based on inflation expectations (E43) |
| long-term bonds (G12) | fiscal costs incurred by countries with high debt levels (H69) |
| mispricing effect due to central bank's credibility issues (E52) | substantial impacts on debt accumulation (G51) |
| differing debt structures (G32) | confounding factors in fiscal impacts (H39) |
| economic conditions across countries (F69) | confounding factors in fiscal impacts (H39) |