Shared Problem, Shared Solution: Benefits from Fiscal-Monetary Interactions in the Euro Area

27 Pages Posted: 26 Jul 2023

See all articles by Robert Beyer

Robert Beyer

International Monetary Fund (IMF)

Rupa Duttagupta

International Monetary Fund (IMF)

Alexandra Fotiou

International Monetary Fund (IMF)

Keiko Honjo

International Monetary Fund (IMF)

Mark Horton

International Monetary Fund (IMF)

Zoltan Jakab

International Monetary Fund

Jesper Lindé

International Monetary Fund (IMF)

Huong (Vina) Nguyen

International Monetary Fund (IMF)

Rafael Portillo

International Monetary Fund (IMF)

Nujin Suphaphiphat

International Monetary Fund (IMF)

Li Zeng

International Monetary Fund (IMF)

Abstract

This paper employs two established macroeconomic models to show that fiscal policy in the euro area can help monetary policy in reducing inflation. Specifically, a fiscal consolidation of 1 percent of GDP for two years and 0.5 percent in the third year across the euro area would ease the policy interest rate by 30-50 basis points relative to the baseline scenario, while lowering inflation. It would also put the public debt-to-GDP ratio on a downward path, with the output costs reversing after the second year. Additionally, a stronger fiscal contribution to the policy mix could mitigate financial fragmentation risks. In the current context of elevated inflation in all euro area economies, the findings suggest two key takeaways: first, synchronized fiscal and monetary policies offer gains even when monetary policy is unconstrained and, second, sharing the burden of lowering inflation through fiscal consolidation among euro area members is beneficial for union-wide inflation reduction, improving debt sustainability and inducing a lower policy rate path.

Keywords: Policy mix, monetary policy, fiscal policy, policy coordination

JEL Classification: E31, E32, E52, E62, F40

Suggested Citation

Beyer, Robert and Duttagupta, Rupa and Fotiou, Alexandra and Honjo, Keiko and Horton, Mark and Jakab, Zoltan and Lindé, Jesper and Nguyen, Huong and Portillo, Rafael and Suphaphiphat, Nujin and Zeng, Li, Shared Problem, Shared Solution: Benefits from Fiscal-Monetary Interactions in the Euro Area. IMF Working Paper No. 2023/149, Available at SSRN: https://ssrn.com/abstract=4521535 or http://dx.doi.org/10.5089/9798400249440.001

Robert Beyer (Contact Author)

International Monetary Fund (IMF) ( email )

Rupa Duttagupta

International Monetary Fund (IMF) ( email )

Kuwait

Alexandra Fotiou

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Keiko Honjo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Mark Horton

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Zoltan Jakab

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Jesper Lindé

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Huong Nguyen

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Rafael Portillo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Nujin Suphaphiphat

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Li Zeng

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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