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How does fiscal policy affect monetary policy in emerging market countries?

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  • Edda Zoli
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    Abstract

    This paper analyses how fiscal policy affects monetary policy in emerging economies. First, it conducts a test for fiscal dominance, and finds that the evidence points clearly to a regime of fiscal dominance in the case of Argentina and Brazil during the 1990s and early 2000s, while for the other countries in the sample the results are mixed. Next, the paper evaluates whether monetary policy accommodates fiscal policy, by assessing whether fiscal variables enter significantly in the central bank's reaction function. The findings indicate that in the emerging markets under consideration the conduct of monetary policy is not directly affected by changes in real primary balances. Then, the paper explores another mechanism through which fiscal policy could affect monetary policy in an emerging economy, by looking at the impact of fiscal policy on country premium and exchange rates. The empirical analysis is conducted through an event study, assessing the impact of news concerning fiscal variables and fiscal policy, on sovereign spread and exchange rate daily movements in Brazil, during the period surrounding the 2002 macroeconomic crisis. The results show that fiscal events have significantly influenced sovereign spreads and exchange rates in that period. Furthermore, fiscal policy actions appear to have contributed to movements in the exchange rates more than unanticipated monetary policy manoeuvres. The findings also suggest that, at that time, fiscal policy might have pushed the economy into an equilibrium in which increases in the policy intervention rate were likely to be associated with a depreciation, rather than an appreciation of the exchange rate.

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    Bibliographic Info

    Paper provided by Bank for International Settlements in its series BIS Working Papers with number 174.

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    Length: 51 pages
    Date of creation: Apr 2005
    Date of revision:
    Handle: RePEc:bis:biswps:174

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    Related research

    Keywords: Monetary Policy; Fiscal Policy; joint analysis of fiscal and monetary policy;

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    References

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    1. António Afonso, 2002. "Disturbing the fiscal theory of the price level: Can it fit the eu-15?," 10th International Conference on Panel Data, Berlin, July 5-6, 2002 B4-3, International Conferences on Panel Data.
    2. Martin Uribe & Vivian Z. Yue, 2003. "Country Spreads and Emerging Countries: Who Drives Whom?," NBER Working Papers 10018, National Bureau of Economic Research, Inc.
    3. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
    4. Kitchen, John, 1996. "Domestic and international financial market responses to Federal deficit announcements," Journal of International Money and Finance, Elsevier, vol. 15(2), pages 239-254, April.
    5. Pierpaolo Benigno & Michael Woodford, 2003. "Optimal Monetary and Fiscal Policy: A Linear Quadratic Approach," NBER Working Papers 9905, National Bureau of Economic Research, Inc.
    6. Favero, Carlo A & Giavazzi, Francesco, 2004. "Inflation Targeting and Debt: Lessons from Brazil," CEPR Discussion Papers 4376, C.E.P.R. Discussion Papers.
    7. Joe Peek & Eric S. Rosengren, 1999. "Determinants of the Japan Premium: Actions Speak Louder Than Words," NBER Working Papers 7251, National Bureau of Economic Research, Inc.
    8. Lawrence J. Christiano & Terry J. Fitzgerald, 2000. "Understanding the fiscal theory of the price level," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-38.
    9. Jorge A. Chan-Lau & Yoon Sook Kim, 2004. "Equity Prices, Credit Default Swaps, and Bond Spreads in Emerging Markets," IMF Working Papers 04/27, International Monetary Fund.
    10. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Optimal fiscal and monetary policy under imperfect competition," Journal of Macroeconomics, Elsevier, vol. 26(2), pages 183-209, June.
    11. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    12. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
    13. Minella, Andre & de Freitas, Paulo Springer & Goldfajn, Ilan & Muinhos, Marcelo Kfoury, 2003. "Inflation targeting in Brazil: constructing credibility under exchange rate volatility," Journal of International Money and Finance, Elsevier, vol. 22(7), pages 1015-1040, December.
    14. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
    15. Olivier Blanchard, 2004. "Fiscal Dominance and Inflation Targeting: Lessons from Brazil," NBER Working Papers 10389, National Bureau of Economic Research, Inc.
    16. Richard Cantor & Frank Packer, 1995. "Sovereign credit ratings," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 1(Jun).
    17. Klaus Schmidt-Hebbel & Alejandro M. Werner, 2002. "Inflation Targeting in Brazil, Chile, and Mexico: Performance, Credibility, and the Exchange Rate," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
    18. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Vladimir Tomsik, 2012. "Some insights into monetary and fiscal policy interactions in the Czech Republic," BIS Papers chapters, in: Bank for International Settlements (ed.), Fiscal policy, public debt and monetary policy in emerging market economies, volume 67, pages 161-171 Bank for International Settlements.
    2. Janak Raj & Khundrakpam J K & Dipika Das, 2011. "An Empirical Analysis of Monetary and Fiscal Policy Interaction in India," Working Papers id:4504, eSocialSciences.
    3. Pablo Mendieta Ossio & Hugo Rodriguez Gonzales, 2005. "Interacción de la política fiscal con la política monetaria en el MERCOSUR y países asociados," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 8(1), pages 49-97, December.
    4. International Monetary Fund, 2008. "Fiscal and Monetary Anchors for Price Stability," IMF Working Papers 08/121, International Monetary Fund.
    5. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.

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