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Does monetary policy influence euro area fiscal sustainability?

António Afonso and Francisco Gomes-Pereira

Economic Modelling, 2025, vol. 152, issue C

Abstract: This paper studies the impact of monetary policy on fiscal sustainability in the euro area. We extend a standard fiscal reaction function by introducing a monetary policy stance variable as an interaction term, allowing us to assess how monetary policy influenced fiscal dynamics. Our study yields two main findings. First, an expansionary monetary policy stance in response to rising debt-to-GDP levels is associated with lower primary balance changes, potentially supporting fiscal sustainability in the short term. Second, when considering exogenous monetary policy shocks, a monetary tightening significantly deteriorates primary balances, potentially straining fiscal sustainability. These results highlight the importance of monetary-fiscal interactions for fiscal sustainability in the euro area.

Keywords: Monetary policy stance; Fiscal sustainability; Debt sustainability (search for similar items in EconPapers)
JEL-codes: E52 E58 E63 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002688

DOI: 10.1016/j.econmod.2025.107273

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