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The Fiscal Channel of Monetary Policy

Author

Listed:
  • Max Breitenlechner
  • Martin Geiger
  • Mathias Klein

Abstract

This paper empirically quantifies the importance of fiscal policy in shaping the monetary policy transmission mechanism and derives implications for monetary-fiscal interactions. First, we document that a contractionary monetary policy shock, besides lowering output and prices, leads to a pronounced adjustment in fiscal measures and a significant increase in the fiscal deficit. We then construct different structural counterfactuals, in which we shut down the endogenous responses of fiscal measures following a monetary policy shock. The impact of a monetary policy shock on output is more than halved by the endogenous adjustment in tax revenues, whereas the public transfer system significantly reduces the impact on prices. Thus, the tax system considerably improves the trade-off between price and output stabilization the central bank faces, whereas the transfer system worsens it. Finally, we show that changes in the fiscal framework can enhance monetary policy effectiveness.

Suggested Citation

  • Max Breitenlechner & Martin Geiger & Mathias Klein, 2024. "The Fiscal Channel of Monetary Policy," Working Papers 2024-07, Faculty of Economics and Statistics, Universität Innsbruck.
    • Handle: RePEc:inn:wpaper:2024-07
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    More about this item

    Keywords

    Monetary policy; fiscal channel; monetary fiscal policy interaction; structural counterfactuals; Bayesian proxy structural VAR models.;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

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