Monetary–fiscal policy interaction and fiscal inflation: A tale of three countries

Abstract

We study how the interaction of monetary and fiscal policy shapes the low-frequency relationship between fiscal stance and inflation in the United States, the United Kingdom, and Germany. Building on a New Keynesian model that allows for different monetary–fiscal regimes, we estimate regime dynamics using Bayesian methods and extract the implied contributions of fiscal and monetary shocks to inflation. We find that periods of weak monetary dominance or fiscal dominance are associated with a stronger link between deficits and inflation, whereas under monetary dominance the connection largely disappears. Our results suggest that the institutional configuration of monetary and fiscal policy is crucial for understanding episodes of “fiscal inflation” and their cross-country differences.

Citation

Kliem, Martin, Alexander Kriwoluzky, and Samad Sarferaz (2016). “Monetary–Fiscal Policy Interaction and Fiscal Inflation: A Tale of Three Countries.” European Economic Review 88: 158–184.

@article{KKS2016b,
title = {Monetary–fiscal policy interaction and fiscal inflation: A tale of three countries},
author = {Martin Kliem and Alexander Kriwoluzky and Samad Sarferaz},
journal = {European Economic Review},
volume = {88},
pages = {158-184},
year = {2016},
note = {SI: The Post-Crisis Slump},
issn = {0014-2921},
doi = {https://doi.org/10.1016/j.euroecorev.2016.02.023},
keywords = {Time-varying VAR, Inflation, Public deficits},
}