Monetary policy surprise shocks under different fiscal regimes: A panel analysis of the Euro Area

Antonio Afonso, José Alves and Serena Ionta

Journal of International Money and Finance, 2025, vol. 156, issue C

Abstract: We examine the impact of surprise shocks on real output and price levels, conditioned on different fiscal stances, using quarterly data from 2001Q4 to 2021Q4 for 19 Euro Area countries. Employing local projection methods, we find that the influence of monetary shocks depends on each country’s fiscal position. Specifically, while high debt amplifies monetary policy’s contractionary effect on output, the “Ricardian" nature of fiscal policy plays a pivotal role in price responses. Notably, in the high-debt and low-sustainability regime, we observe “fiscal inflation" where monetary tightening raises prices instead of containing them. Consistent with the Fiscal Theory of Price Level, this occurs when agents anticipate insufficient fiscal adjustments to offset the debt burden, creating inflationary pressures. Our study introduces a novel approach by integrating Bohn’s fiscal reaction function within a time-varying framework and analyzing interactions between fiscal stances and monetary shocks in the Euro Area. These findings carry significant policy implications, suggesting monetary authorities should consider fiscal conditions when implementing policy measures.

Keywords: Monetary policy surprises; Public debt; Fiscal sustainability; Local projection models; Fiscal-monetary policy mix; Euro Area (search for similar items in EconPapers)
JEL-codes: C32 E58 E62 E63 (search for similar items in EconPapers)
Date: 2025
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0261560625000762
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Monetary Policy Surprise Shocks under Different Fiscal Regimes: A Panel Analysis of the Euro Area (2023)
Working Paper: Monetary policy surprises shocks under different fiscal regimes: a panel analysis of the Euro Area (2023)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:156:y:2025:i:c:s0261560625000762

DOI: 10.1016/j.jimonfin.2025.103341

Access Statistics for this article

Journal of International Money and Finance is currently edited by J. R. Lothian

More articles in Journal of International Money and Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().