A monetary policy perspective on the euro area fiscal reaction function

Guido Wolswijk

No 3172, Working Paper Series from European Central Bank

Abstract: This paper examines how fiscal policy in the euro area reacts to monetary policy, by estimating fiscal policy reaction functions for the period 1999-2019. Inclusion of the monetary policy stance in the fiscal reaction function, approximated by a shadow interest rate, is a relatively novel aspect in this type of analysis. The findings suggest that fiscal policy acts in a substitutive manner, its stance moving in the opposite direction of monetary policy, though this effect may have ceased operating during ECB’s quantitative easing. Using local projections, the substitutive effect is found to increase over time before turning broadly neutral. Analysing the fiscal response to other monetary policy relevant variables - government debt and the output gap -, outcomes suggests that budget balances react positively to government debt, supporting fiscal sustainability, and that fiscal policy acts countercyclically in recessions. JEL Classification: E61, H11, H62

Keywords: debt sustainability; monetary policy transmission; policy interactions; reaction function (search for similar items in EconPapers)
Date: 2026-01
Note: 339143
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20263172

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