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Monetary policy and sovereign debt: Does the ECB take the eurozone’s fiscal risks into account?

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  • Andrew Hughes Hallett
  • John Lewis

Abstract

In the standard Taylor rule, fiscal variables are absent and the central bank is assumed to respond in the same way to a given inflation-output gap outlook regardless of the stance of fiscal policy or the outlook for government debt. This paper puts that assumption to the test. Estimating Taylor rules for the ECB using real time data, we find that there is no direct response to the usual instrument of fiscal policy, the cyclical adjusted primary balance. But there is a clear response to the level of debt. Monetary policy tightens by 25 basis points for every 2.5 pp rise in the expected debt to GDP ratio. With ex-post data, we see the opposite: the ECB appears, unfairly since they didn’t have the data, to have acted as if it loosened in periods with a forecasted debt build-up (i.e. in recessions), but tightened in response to past fiscal excesses. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Andrew Hughes Hallett & John Lewis, 2015. "Monetary policy and sovereign debt: Does the ECB take the eurozone’s fiscal risks into account?," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 42(3), pages 499-520, August.
    • Handle: RePEc:kap:empiri:v:42:y:2015:i:3:p:499-520
    DOI: 10.1007/s10663-014-9260-4
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    Cited by:

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    2. Diessner, Sebastian & Lisi, Giulio, 2019. "Masters of the ‘masters of the universe’? Monetary, fiscal and financial dominance in the Eurozone," LSE Research Online Documents on Economics 100754, London School of Economics and Political Science, LSE Library.
    3. Hughes Hallett, Andrew & Mavrodimitrakis, Christos, 2019. "Cooperation vs. leadership in a core-periphery monetary union: Inter-country vs. inter-institutional policy coordination," Journal of Macroeconomics, Elsevier, vol. 59(C), pages 103-122.

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    More about this item

    Keywords

    Policy co-ordination; Fiscal policy; Monetary policy; Real time data; E63; E61;
    All these keywords.

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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