Monetary-Fiscal Crosswinds in the European Monetary Union
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.