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The Relationship between Fiscal and Monetary Policies in Colombia: An Empirical Exploration of the Credit Risk Channel

Ignacio Lozano-Espitia and Fernando Arias-Rodríguez ()

Borradores de Economia from Banco de la Republica de Colombia

Abstract: This paper aims to provide evidence on the relationship between fiscal and monetary policy in Colombia through an empirical exploration of the credit risk channel. Under this approach, fiscal policy plays an important explanatory role in the sovereign risk premium, which, in turn, could affect the exchange rate and inflation expectations. The Central Bank reacts to inflation expectations using the policy interest rate; consequently, such reaction could be indirectly influenced by fiscal behavior. Using monthly data from January 2003 to December 2019, we estimate both jointly and independently the reduced-form core equations of a system that describes the credit risk channel in a small open economy. Our findings are in line with the model predictions. Fiscal policy affected the country’s sovereign risk during this period, but only slightly. Hence, there is insufficient evidence to sustain the idea that monetary policy has been significantly influenced by government fiscal management. **** Este documento analiza la relación entre las políticas fiscal y monetaria en Colombia, mediante la evaluación empírica del canal de riesgo crediticio. En este enfoque, la política fiscal explicaría la prima de riesgo soberano la cual, a su vez, puede afectar la tasa de cambio nominal y las expectativas de inflación. El Banco Central reacciona a las expectativas de inflación usando la tasa de interés de política; así, dicha reacción estaría influenciada indirectamente por la política fiscal. Utilizando información mensual de 2003 a 2019 se estima, de manera conjunta e independiente, un sistema de ecuaciones que describe de forma reducida el funcionamiento del canal de riesgo de crédito en una economía pequeña y abierta. Nuestros resultados son coherentes con las predicciones del modelo teórico. Se encuentra que la política fiscal afectó el riesgo soberano del país durante el período de estudio, aunque de manera modesta. Sin embargo, no hay suficiente evidencia para afirmar que la política monetaria haya sido influenciada de manera importante por la política fiscal, descartándose situaciones de dominancia fiscal.

Keywords: Policy interaction; fiscal policy; monetary policy; sovereign credit risk; Interacción de políticas; política fiscal; política monetaria; riesgo de crédito soberano. (search for similar items in EconPapers)
JEL-codes: E52 E61 E62 E63 (search for similar items in EconPapers)
Pages: 22
Date: 2022-04
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-rmg
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https://doi.org/10.32468/be.1196

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Persistent link: https://EconPapers.repec.org/RePEc:bdr:borrec:1196

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