Tracking Monetary-Fiscal Interactions across Time and Space
by Michal Frantaa, Jan Libichb, and Petr Stehlíkc
The long-term fiscal outlook of most high-income countries
is grim. Should independent central bankers be afraid
of an unpleasant monetarist arithmetic, i.e., fiscal imbalances
spilling over to monetary policy and jeopardizing price stability?
To provide some insights, this paper tracks the interactions
between fiscal and monetary policies in the data since
1980 for Australia, Canada, Japan, Switzerland, the United
Kingdom, and the United States. In doing so it uses a combination
of time-varying parameter vector autoregression with
sign, magnitude, and contemporaneous restrictions identification.
Unlike conventional approaches, this can capture changes
in monetary and fiscal behavior that are gradual and differ
across the two policies. Our results show that in the United
States the degree of monetary policy accommodation of fiscal
shocks (debt-financed government spending) increased gradually
between the late 1980s and the 2008 crisis, i.e., over the
whole tenure of Chairman Greenspan. In contrast, it seems
to have decreased over this period in the United Kingdom, Australia, Switzerland, and Canada. Our benchmark analysis
and several robustness checks show that legislating numerical
inflation targets may account for some of the country differences,
presumably because they may shift the strategic power
from fiscal to monetary policy. We conclude by considering the
implications of our results for the long-term likelihood of an
unpleasant monetarist arithmetic in the six countries.
JEL Code: E61, C10.
Full article (PDF, 61 pages, 11443 kb)
Discussion by Troy Davig
a Czech National Bank
b La Trobe University, CAMA, and VSB-TU Ostrava
c University of West Bohemia