Fiscal R-Star: Fiscal-Monetary Tensions and Implications for Policy

IMF Working Papers, August 9, 2024

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Fiscal R-Star: Fiscal-Monetary Tensions and Implications for Policy

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Bibliographic details

• Authors: Marijn A. Bolhuis, Jakree Koosakul, Neil Shenai
• Published: August 9, 2024
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9798400282126.001

Overview

• Since the Global Financial Crisis, fiscal policy in advanced economies has become more “active” — increasingly unresponsive to rising debt levels.
• The paper introduces “fiscal r-star,” defined as the real interest rate required to stabilize debt levels when:
  • the primary balance is set exogenously,
  • output is growing at potential, and
  • inflation is at target.
• The difference between monetary r-star and fiscal r-star is termed the “fiscal monetary gap” and is proposed as a proxy for fiscal-monetary policy tensions.
• Current estimates indicate that fiscal-monetary tensions are at historic highs.
• Given a tepid growth outlook, the paper suggests growth-enhancing reforms and fiscal consolidation, among other policy adjustments, may be needed to attenuate fiscal-monetary tensions over time.

Fiscal r-star Concept and Fiscal-Monetary Gap

• Fiscal r-star: the real interest rate required to stabilize debt under specified assumptions (exogenous primary balance, output at potential, inflation at target).
• Fiscal monetary gap: monetary r-star minus fiscal r-star; interpreted as a proxy for fiscal-monetary policy tensions.

Empirical Findings (Data and Associations)

• Data: analysis covers over 140 years of data from 16 advanced economies.
• Associations found with larger fiscal-monetary gaps:
  • rising debt levels,
  • higher inflation,
  • financial repression,
  • lower real returns on bonds and cash,
  • elevated risks of future debt crises,
  • elevated risks of future inflation crises,
  • elevated risks of future currency crises,
  • elevated risks of future housing crises,
  • elevated risks of future systemic crises.

Policy Implications and Recommendations

• To attenuate fiscal-monetary tensions over time, the paper highlights potential adjustments including:
  • growth-enhancing reforms,
  • fiscal consolidation,
  • other policy adjustments appropriate to the context of active fiscal policy and elevated fiscal-monetary gaps.

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