Fiscal R-Star: Fiscal-Monetary Tensions and Implications for Policy

By Marijn A. Bolhuis, Jakree Koosakul, Neil Shenai

August 9, 2024

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Marijn A. Bolhuis, Jakree Koosakul, and Neil Shenai. Fiscal R-Star: Fiscal-Monetary Tensions and Implications for Policy, (USA: International Monetary Fund, 2024) accessed November 23, 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

Since the Global Financial Crisis, fiscal policy in advanced economies has become more “active” – that is, increasingly unresponsive to rising debt levels. This paper explores tensions between active fiscal and monetary policies by introducing the concept of “fiscal r-star,” which is the real interest rate required to stabilize debt levels when the primary balance is set exogenously, output is growing at potential, and inflation is at target. It is proposed that the difference between monetary r-star and fiscal r-star—referred to as the “fiscal monetary gap”—is a proxy for fiscal-monetary policy tensions. An analysis of over 140 years of data from 16 advanced economies shows that larger fiscal-monetary gaps are associated with rising debt levels, higher inflation, financial repression, lower real returns on bonds and cash, with elevated risks of future debt, inflation, currency, housing, and systemic crises. Current estimates indicate that fiscal-monetary tensions are at historic highs. Given the tepid growth outlook, growth-enhancing reforms and fiscal consolidation, among other policy adjustments, may be needed to attenuate fiscal-monetary tensions over time.

Subject: Financial services, Fiscal policy, Fiscal stance, Inflation, Inflation targeting, Monetary policy, Prices, Public debt, Real interest rates

Keywords: Debt level, Debt liquidation, Financial repression, Fiscal consolidation, Fiscal dominance, Fiscal policy, Fiscal policy to debt, Fiscal r-star, Fiscal stance, Fiscal-monetary gap, Fiscal-monetary interactions, Fiscal-monetary policy tension, Global, IMF working paper 24/174, Inflation, Inflation targeting, Monetary policy, Policy space, Real interest rates

Publication Details

Pages:

56
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2024/174
Stock No:

WPIEA2024174
ISBN:

9798400282126
ISSN:

1018-5941

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