How Financial Stress Can Impact Fiscal and Monetary Policies: Threshold VAR Analysis for Brazilian Economy

Roberta Moreira Wichmann, Werley Cordeiro and João F. Caldeira ()
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Roberta Moreira Wichmann: Brazilian Institute of Education, Development and Research–IDP, Economics Graduate Program, Brasília 70200-670, DF, Brazil
Werley Cordeiro: Department of Economics, Universidade Federal de Santa Catarina, Florianopolis 88049-970, SC, Brazil
João F. Caldeira: Department of Economics, Universidade Federal de Santa Catarina & CNPq, CSE-UFSC, R. Roberto Sampaio Gonzaga-Trindade, Florianópolis 88040-900, SC, Brazil

Econometrics, 2024, vol. 12, issue 4, 1-23

Abstract: This study examines economic policy responses in Brazil during periods of financial stress, with a particular emphasis on the dynamics of both the impulse and rule components of fiscal policy. We offer novel empirical evidence on policy responses under both low and high stress conditions, utilizing monthly data that span the past two decades. To this end, we construct a Financial Stress Index (FSI) and integrate it into a threshold-VAR framework. Additionally, we employ five distinct methodologies to decompose fiscal policy into its impulse and rule components. Our analysis yields two main findings. First, fiscal policy exhibits procyclical behavior in its impulse component and countercyclical behavior in its rule component across both regimes. Second, while monetary policy is countercyclical during high stress conditions, its impact remains largely statistically non-significant. These results suggest that policymakers should exercise caution when timing the implementation of expansionary fiscal policies, carefully considering the phase of the business cycle. Moreover, our findings carry significant implications for the ongoing discourse on fiscal stimulus and debt stabilization strategies, particularly in the context of financial stress.

Keywords: fiscal policy; financial stress index; threshold VAR; generalized impulse response analysis (search for similar items in EconPapers)
JEL-codes: B23 C C00 C01 C1 C2 C3 C4 C5 C8 (search for similar items in EconPapers)
Date: 2024
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