The Comovement between Monetary and Fiscal Policy Instruments during the Post-War Period in the U.S

Jesús Vázquez Pérez

No 1988-088X, DFAEII Working Papers from University of the Basque Country - Department of Foundations of Economic Analysis II

Abstract: This paper empirically studies the dynamic relationship between monetary and fiscal policies by analyzing the comovements between the Fed funds rate and the primary deficit/output ratio. Simple economic thinking establishes that a negative correlation between Fed rate and deficit arises whenever the two policy authorities share a common stabilization objective. However, when budget balancing concerns lead to a drastic deficit reduction the Fed may reduce the Fed rate in order to smooth the impact of fiscal policy, which results in a positive correlation between these two policy instruments. The empirical results show (i) a significant negative comovement between Fed rate and deficit and (ii) that deficit and output gap Granger-cause the Fed funds rate during the post-Volcker era, but the opposite is not true.

Keywords: fed rate; deficit; comovement; switching regimes (search for similar items in EconPapers)
Date: 2008-04
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Dpto. de Fundamentos del Análisis Económico II, = Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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