Tracking Monetary - Fiscal Interactions Across Time and Space

The fiscal position of many countries is worrying – and getting worse. Should formally independent central bankers be concerned about observed fiscal excesses 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 across time and space. It makes three main contributions. The first one is methodological: we combine two recent econometric procedures – time-varying parameter vector autoregression with sign restrictions identification – and discuss the advantages of this approach. The second contribution is positive: we show how monetary-fiscal interactions and other macroeconomic variables have changed over time in six industrial countries (Australia, Canada, Japan, Switzerland, the UK, and the U.S.). The third contribution is normative: the paper highlights the role of the institutional design of each policy on the outcomes of both policies. Specifically, it first offers some evidence that an explicit long-term commitment of monetary policy (a legislated numerical target for average inflation) gives the central bank stronger grounds for not accommodating debt-financed fiscal shocks. Our second set of (albeit weaker) results then indicates that this threat of a policy tug-ofwar may improve the government’s incentives and fiscal outcomes – reducing the probability of both a fiscal crisis and unpleasant monetarist arithmetic. JEL Codes: C10, E61.