Shared Problem, Shared Solution: Benefits from Fiscal-Monetary Interactions in the Euro Area
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Summary:
This paper employs two established macroeconomic models to show that fiscal policy in the euro area can help monetary policy in reducing inflation. Specifically, a fiscal consolidation of 1 percent of GDP for two years and 0.5 percent in the third year across the euro area would ease the policy interest rate by 30-50 basis points relative to the baseline scenario, while lowering inflation. It would also put the public debt-to-GDP ratio on a downward path, with the output costs reversing after the second year. Additionally, a stronger fiscal contribution to the policy mix could mitigate financial fragmentation risks. In the current context of elevated inflation in all euro area economies, the findings suggest two key takeaways: first, synchronized fiscal and monetary policies offer gains even when monetary policy is unconstrained and, second, sharing the burden of lowering inflation through fiscal consolidation among euro area members is beneficial for union-wide inflation reduction, improving debt sustainability and inducing a lower policy rate path.
Series:
Working Paper No. 2023/149
Subject:
Fiscal consolidation Fiscal policy Fiscal stance Inflation Prices Public debt
Frequency:
regular
English
Publication Date:
July 21, 2023
ISBN/ISSN:
9798400249051/1018-5941
Stock No:
WPIEA2023149
Format:
Paper
Pages:
27
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