Monetary Policy under Fiscal Risk

Mauricio Villamizar-Villegas, Oscar Valencia, Andres Felipe Prado Garcia and Nicolás Aya

No 14843, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: Fiscal stance and sovereign credibility shape monetary policy transmission even outside fiscal dominance. Using a panel of advanced and emerging economies since the mid-1990s, we show that sovereign-risk regimes differ less by headline debt than by borrowing costs, debt composition, and interest burdens. Elevated sovereign risk weakens the transmission of monetary policy, foreign-exchange intervention, macroprudential tools, and capital- flow measures to prices, exchange rates, and output. A small open-economy model with a fiscal block can rationalize these patterns. Emerging markets operate under tighter fiscal constraints, rely more on multi-instrument configurations, and face a narrower stabilization frontier, including cases in which conventional tightening loses its disinflationary effect.

Keywords: Monetary policy transmission; sovereign risk; Fiscal space; Foreing-exchange intervention; Macroprudential (search for similar items in EconPapers)
JEL-codes: E52 E62 F31 F34 (search for similar items in EconPapers)
Date: 2026-11
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Persistent link: https://EconPapers.repec.org/RePEc:idb:brikps:14843

DOI: 10.18235/0014598

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