The ECB and the Cost of Independence. Unearthing a New Doom-Loop in the European Monetary Union
62 Pages Posted: 15 Jan 2021
Date Written: January 1, 2021
Central Bank Independence has often been praised as a “free lunch” as it lowers inflation with no costs to output. This paper, instead, claims that in a peculiar monetary union such as the European Monetary Union (EMU) defending the independence during a financial crisis can be macroeconomically costly: unconventional monetary policies may expose the European Central Bank (ECB) to the threat of fiscal dominance which, in turn, might endogenously shift the ECB’s fiscal stance toward fiscal conservatism. Fiscally hawkish signals can then depress GDP and inflation, thereby forcing the ECB to prolong the unconventional stimuli to achieve its target. This paper finds evidence of this new “doom-loop” at the core of the EMU.
Keywords: ECB, monetary-fiscal interaction, CBI, unconventional monetary policy, EMU, fiscal communication
JEL Classification: E52, E58, E61, E63
Suggested Citation: Suggested Citation