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Interactions Between Monetary and Fiscal Policy: How Monetary Conditions Affect Fiscal Consolidation

  • Rudiger Ahrend
  • Pietro Catte
  • Robert W.R. Price

This paper assesses how and in what circumstances, fiscal consolidations are affected by monetary conditions, using data covering 24 OECD countries over the past 25 years, Focusing on fiscal consolidation “episodes”, it is found that these tend to occur when large budget deficits threaten sustainability and usually when other macroeconomic indicators -- inflation, the exchange rate and unemployment -- suggest a “crisis” situation. After controlling for these factors, the paper finds strong econometric evidence that consolidation efforts are more likely to be pursued and to succeed if the monetary policy stance is eased in the initial stages of the episode, thus contributing to offsetting the contractionary impact of fiscal tightening. However, the link is far from mechanical and there are also counter-examples where monetary easing was followed by aborted consolidation efforts. Central bank independence explicitly precludes direct responses of monetary policy to fiscal actions. However, the paper also provides evidence that the indirect reaction of monetary policy and financial markets to fiscal consolidation may be influenced by the quality of fiscal adjustment, as short and long-term interest rates are more likely to fall during episodes characterised by greater reliance on current expenditure cuts. While this means that causality runs both ways, the paper provides evidence that, even after controlling for this proxy of fiscal adjustment quality, changes in monetary stance do affect the chances that a fiscal retrenchment plan will be successfully pursued. Interactions entre la politique monétaire et budgétaire : L'effet des conditions monétaires sur les consolidations budgétaires Cet article, utilisant des données relatives à 24 pays de l’OCDE sur les 25 dernières années, examine comment et dans quelles circonstances des ajustements budgétaires sont affectés par les conditions monétaires. Les ajustements budgétaires interviennent le plus souvent lorsque d’importants déficits menacent la soutenabilité des finances publiques, ou lorsque d'autres indicateurs macroéconomiques -- inflation, taux de change ou niveau de chômage -- sont très dégradés. En contrôlant ces variables, l’article apporte des preuves économétriques robustes suivant lesquelles les efforts de consolidation budgétaire ont davantage de chance d’être mis en oeuvre et couronnés de succès si la politique monétaire est accommodante dans la période initiale de l’ajustement, contribuant ainsi à amortir l’effet défavorable pour la croissance du resserrement budgétaire. Le lien n’est cependant pas mécanique, comme l’atteste l’existence d’épisodes de desserrement monétaire suivis d’un abandon des efforts d’ajustement fiscal. Par ailleurs, si l’indépendance des banques centrales fait explicitement obstacle à une réponse directe de la politique monétaire aux opérations budgétaires, l’article montre que la qualité de l’ajustement fiscal peut indirectement influer sur les banques centrales et les marches financiers. Par exemple, les taux d'intérêt à court et long terme semblent se replier davantage si l’ajustement budgétaire prend la forme d’une maîtrise stricte des dépenses courantes. Au total, l’influence entre l’ajustement budgétaire et la conduite de la politique monétaire est réciproque mais l’article montre que, même en contrôlant la qualité d'ajustement budgétaire, la politique monétaire continue à influencer la probabilité d’une consolidation des finances publiques d’être menée à bien.

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File URL: http://dx.doi.org/10.1787/414663503428
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Paper provided by OECD Publishing in its series OECD Economics Department Working Papers with number 521.

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Date of creation: 03 Nov 2006
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Handle: RePEc:oec:ecoaaa:521-en
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