ECB paper finds fiscal policy reacts substitutively to monetary policy
A new European Central Bank working paper examines how fiscal policy in the euro area reacted to monetary policy between 1999 and 2019. The study finds that fiscal policy generally moved in the opposite direction to monetary policy, though this effect diminished during quantitative easing.
Fiscal policy's counter-movements
The paper estimates fiscal policy reaction functions for ten euro area countries from 1999 to 2019, incorporating the monetary policy stance via a shadow interest rate.
Findings suggest that fiscal policy generally acts in a substitutive manner, moving in the opposite direction to monetary policy.
For instance, tight monetary policy often led to expansionary fiscal policy, possibly reflecting government concerns about adverse growth impacts.
However, this substitutive role appears to have diminished during the period of the ECB's quantitative easing, becoming broadly muted or even slightly complementary.
Debt, cycles, and sustainability
The study also explores how governments respond to elevated debt levels and the business cycle.
Outcomes indicate that budget balances react positively to government debt, supporting fiscal sustainability and abating concerns about fiscal policy negatively affecting monetary policy conditions.
Furthermore, the paper provides evidence of countercyclical fiscal behavior, with fiscal policy tending to be expansionary when output is below potential, while adopting a neutral stance when output exceeds potential.