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The Comovement between Monetary and Fiscal Policy Instruments during the Post-War Period in the U.S

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  • Vázquez Pérez, Jesús

Abstract

This paper empirically studies the dynamic relationship between monetary and fiscal policies by analyzing the comovements between the Fed funds rate and the primary deficit/output ratio. Simple economic thinking establishes that a negative correlation between Fed rate and deficit arises whenever the two policy authorities share a common stabilization objective. However, when budget balancing concerns lead to a drastic deficit reduction the Fed may reduce the Fed rate in order to smooth the impact of fiscal policy, which results in a positive correlation between these two policy instruments. The empirical results show (i) a significant negative comovement between Fed rate and deficit and (ii) that deficit and output gap Granger-cause the Fed funds rate during the post-Volcker era, but the opposite is not true.

Suggested Citation

  • Vázquez Pérez, Jesús, 2008. "The Comovement between Monetary and Fiscal Policy Instruments during the Post-War Period in the U.S," DFAEII Working Papers 1988-088X, University of the Basque Country - Department of Foundations of Economic Analysis II.
    • Handle: RePEc:ehu:dfaeii:6681
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