Fiscal and monetary interactions in the European countries: panel data analysis

The importance of the decisions made by central banks and governments has been increasing recently, especially in the EU countries. The relationships between short-term interest rates, inflation rates, and public deficits have not been thoroughly described in the literature concerning the recent European cases. It is worth observing how the relationships between the key variables in the field of monetary and fiscal policy behave in various groups of countries, e.g. in countries with low/high General Government deficits or in countries with low high public debt. The aim of the article is to empirically analyse the relationship between interest rates, inflation rates, and public deficits in European countries in the years between 1996–2019. We studied the relationships between interest rates, inflation rates, and public deficits. We turned to dynamic panel data methods (two-step system GMM). First, interest rates and inflation rates have been related following the Taylor-rule direction across the European economies. Second, we have also found a positive relationship between inflation rates and public deficits, but reverting the postulated Sargent and Wallace (1981) hypothesis of seigniorage. Third, deficit and inflation rates have positive relations across European observations but more significantly in the cases of high deficits or with highly indebted economies.