Monetary and Fiscal Policy Coordination During Fiscal Dominance Regimes

Vighneswara Swamy

World Economics, 2020, vol. 21, issue 3, 183-214

Abstract: This study empirically examines the interaction between monetary and fiscal policy by using vector auto regressions (VAR) and a vector error-correction model (VECM) and explores the need for coordination. • We also analyse a Stackelberg interaction model with government leadership to know the strategic interaction between monetary and fiscal policy. The findings show that an unexpected increase in the monetary policy effect: (i) has a contractionary impact on economic growth; (ii) leads to a gradual decline in inflation; (iii) tightens liquidity conditions; and (iv) leads to a rise in bond yields. On the other hand, an unexpected increase in the fiscal policy effect: (i) has a positive effect on GDP growth; (ii) prompts an initial decline, then a gradual rise in inflation levels; (iii) leads to falling bond yields. Monetary policy is found to be more responsive to fiscal policy effects. The results imply that there is a greater need for effective coordination between monetary and fiscal policy as a sufficient condition to achieve economic stability.

Date: 2020
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