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Does monetary policy influence euro area fiscal sustainability?

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  • Afonso, António
  • Gomes-Pereira, Francisco

Abstract

This paper studies the impact of monetary policy on fiscal sustainability in the euro area. We extend a standard fiscal reaction function by introducing a monetary policy stance variable as an interaction term, allowing us to assess how monetary policy influenced fiscal dynamics. Our study yields two main findings. First, an expansionary monetary policy stance in response to rising debt-to-GDP levels is associated with lower primary balance changes, potentially supporting fiscal sustainability in the short term. Second, when considering exogenous monetary policy shocks, a monetary tightening significantly deteriorates primary balances, potentially straining fiscal sustainability. These results highlight the importance of monetary-fiscal interactions for fiscal sustainability in the euro area.

Suggested Citation

  • Afonso, António & Gomes-Pereira, Francisco, 2025. "Does monetary policy influence euro area fiscal sustainability?," Economic Modelling, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002688
    DOI: 10.1016/j.econmod.2025.107273
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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