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

By Robert C. M. Beyer, Rupa Duttagupta, Alexandra Fotiou, Keiko Honjo, Mark A Horton, Zoltan Jakab, Vina Nguyen, Rafael A Portillo, Jesper Lindé, Nujin Suphaphiphat, Li Zeng

July 21, 2023

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Robert C. M. Beyer, Rupa Duttagupta, Alexandra Fotiou, Keiko Honjo, Mark A Horton, Zoltan Jakab, Vina Nguyen, Rafael A Portillo, Jesper Lindé, Nujin Suphaphiphat, and Li Zeng. Shared Problem, Shared Solution: Benefits from Fiscal-Monetary Interactions in the Euro Area, (USA: International Monetary Fund, 2023) accessed December 22, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

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.

Subject: Fiscal consolidation, Fiscal policy, Fiscal stance, Inflation, Prices, Public debt

Keywords: Annex I. Policy synchronization, Fiscal consolidation, Fiscal policy, Fiscal policy in the euro area, Fiscal stance, Global, Inflation, Inflation reduction, Monetary policy, Monetary policy interaction, Policy coordination, Policy mix, Synchronized fiscal policy

Publication Details

Pages:

27
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/149
Stock No:

WPIEA2023149
ISBN:

9798400249051
ISSN:

1018-5941

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