Monetary-Fiscal Crosswinds in the European Monetary Union

The BIS webinar by Lucrezia Reichlin followed by a discussion with Otmar Issing on Thursday 3 December 2020

We study the interaction between monetary and fiscal policy in the European Monetary Union (EMU), by estimating an empirical model { based on a newly constructed fiscal dataset for France, Germany, Italy and Spain since 1991 {, informed by the linearised version of the general government intertemporal budget constraint in the monetary union. In the baseline case, the Central Bank targets the average inflation which is a constraint to the budget determination of each country. Each country can issue debt and faces different market rates (and returns) but there are potential fiscal transfers across countries. We find that in all countries, except for Germany, fiscal policy moves passively in the same direction of monetary policy (whether it is defined as a conventional unexpected decline of the short term rate or as a compression of the slope of the yield curve). Empirically, monetary-fiscal coordination is stronger than cross-winds. However, changes in the present and future returns on the market value of the debt are larger than fiscal adjustment and more than offset the effect that the latter has on inflation.

© 2018 by Giovanni Ricco.

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