Fiscal R-Star: Fiscal-Monetary Tensions and Implications for Policy

Tensions between fiscal and monetary policies have become the focus of macroeconomic policy debates in recent years. Yet, there are few direct measures to quantify the degree of such tensions. This paper introduces the concept of "fiscal r-star," which is the real interest rate required to stabilize debt levels when the primary balance is set exogenously, output is growing at potential, and inflation is at target. Based on standard macroeconomic frameworks, we show analytically that the difference between the traditional monetary policy r-star and fiscal r-star—referred to as the "fiscal-monetary gap"— is a useful proxy for fiscal-monetary tensions. Computing the fiscal-monetary gap using 140 years of data from 16 advanced economies, fiscal-monetary tensions are currently at historic highs not seen since World War II. Moreover, larger fiscal-monetary gaps are associated with a range of adverse macroeconomic outcomes, including rising debt levels, higher inflation, exchange rate depreciations, financial repression, as well as elevated risks of future crises. Using the introduced framework, we show analytically how different policy levers can attenuate fiscal-monetary tensions, but provide some initial evidence on why implementation may be challenging today. In the absence of fiscal consolidation, policymakers may increasingly implement policies that undermine central bank independence and resort to financial repression to reduce tensions over time.