ECB study finds euro area fiscal policy reacts to monetary policy stance
A new European Central Bank working paper examines how fiscal policy in the euro area responds to monetary policy. The study finds a substitutive relationship where fiscal policy generally moves in the opposite direction of monetary policy.
Fiscal policy's counter-move
The paper's findings indicate that euro area fiscal policy generally takes a substitutive role to monetary policy in the short term.
This means that tight monetary policy often leads to expansionary fiscal policies, potentially reflecting governments' concerns about adverse impacts on economic growth.
However, during the period of the ECB's large-scale asset purchases (quantitative easing), this substitutive effect appears to have diminished, becoming broadly muted or even slightly complementary.
The analysis uses shadow interest rates to comprehensively capture the monetary policy stance, including non-interest rate measures.
Debt and cycles shape budgets
Beyond monetary policy interactions, the study also explores how governments respond to elevated debt levels and business cycles.
It suggests that governments with high debt pursue budgetary surpluses to maintain long-run fiscal sustainability, thereby alleviating concerns about fiscal policy negatively impacting monetary policy conditions.
Furthermore, the paper provides evidence of countercyclical fiscal behavior, with policy tending to be expansionary when output is below potential, while adopting a neutral stance when output exceeds potential.