The Fiscal Channel of Monetary Policy

Max Breitenlechner (), Martin Geiger () and Mathias Klein ()

Working Papers from Faculty of Economics and Statistics, Universität Innsbruck

Abstract: This paper empirically studies the importance of fiscal policy in shaping the monetary policy transmission mechanism. We document that a contractionary monetary policy shock, in addition to lowering output and prices, induces a pronounced adjustment in fiscal measures, leading to persistent primary deficits and debt accumulation. This debt build-up is primarily driven by automatic stabilizers, while higher interest payments play a secondary role. Utilizing structural counterfactuals to discipline the debt accumulation, we find that front- loading the fiscal consolidation considerably amplifies the monetary effects. Furthermore, these counterfactuals show that the timing of the consolidation alters the composition of the fiscal adjustment, with distinct implications for real and nominal outcomes. The impact of a monetary policy shock on prices is more than halved by the endogenous adjustment in social transfers, whereas the tax system significantly reduces the effect on output.

Keywords: Monetary policy; fiscal channel; monetary fiscal policy interaction; structural counterfactuals; Bayesian proxy structural VAR models. (search for similar items in EconPapers)
JEL-codes: E32 E52 E63 (search for similar items in EconPapers)
Date: 2024-07
New Economics Papers: this item is included in nep-cba and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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