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Complementarities Between Fiscal Policy and Monetary Policy—Literature Review

Author

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  • Wei Dong
  • Geoffrey Dunbar
  • Christian Friedrich
  • Dmitry Matveev
  • Romanos Priftis
  • Lin Shao

Abstract

This paper reviews and summarizes the literature on the complementary relationship between fiscal policy and monetary policy. We focus on four types of fiscal policy: (1) automatic stabilizers, (2) state-contingent non-discretionary fiscal policy, (3) discretionary fiscal stimulus and (4) government credit policies. The literature shows that automatic fiscal stabilizers can play a role in stabilizing business cycle fluctuation. But because they can have multiple policy objectives, their optimal design remains an open question. An alternative policy framework features state-contingent non-discretionary fiscal expenditures with a pre-committed fiscal spending formula triggered by objective macroeconomic conditions. Such a policy offers the advantage of being timely and easy to communicate; but at the same time, it poses challenges for identifying appropriate triggers and program expenditures with high short-run multipliers. The literature also shows that discretionary fiscal expenditures can support aggregate demand, and some expenditures have short-run multipliers close to, or above, 1. While these expenditures can focus on specific policy priorities that are relevant at the time, their discretionary nature may slow the policy response. When interest rates are close to the effective lower bound (ELB), fiscal stimulus can be particularly effective for complementing the stabilizing efforts of monetary policy. Finally, studies show that government credit policies can mitigate economic downturns that are accompanied by severe financial market distress. However, the effects of scaling up this channel are uncertain.

Suggested Citation

  • Wei Dong & Geoffrey Dunbar & Christian Friedrich & Dmitry Matveev & Romanos Priftis & Lin Shao, 2021. "Complementarities Between Fiscal Policy and Monetary Policy—Literature Review," Discussion Papers 2021-4, Bank of Canada.
  • Handle: RePEc:bca:bocadp:21-4
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    More about this item

    Keywords

    Fiscal policy; Monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • 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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