The Interdependence of Fiscal and Monetary Policy in Uruguay

The global COVID-19 pandemic has called for heightened levels of policy intervention stressing governmnt accounts and amplifying their impact on the macroeconomy through an already nonexistent fiscal space. Policymakers' choices during this disruption may shape the economy for decades to come. The main objective of this investigation is to evaluate the degree of fiscal dominance in Uruguay in 1999-2019 in order to improve the understanding of economic policy not only for theoretical reasons but for applied needs related to good practices and accountability. Two strategies are followed: one, to quantify the fraction of fiscal expenditures that is financed by monetary liabilities and, the other one, to analyze the effects of fiscal deficit on the price level and inflation because inflationary financing may prevent the central bank from reaching its inflation target. Both situations may subordinate the monetary policy to the fiscal policy signaling fiscal dominance. In addition, through the analysis performed to assess the degree of fiscal dominance, it was possible to detect the main determining factors of the Uruguayan price level (inflation) formation during the last two decades. So far, preliminary results suggest that inflation is not exclusively a monetary phenomenon and point to some inflationary financing with a mild degree of fiscal dominance.