Interactions between monetary and fiscal policy: how monetary conditions affect fiscal consolidation

Falling interest rates help reduce government spending

This paper assesses how, and in what circumstances, fiscal adjustments are affected by monetary conditions, using data covering 24 OECD countries over the past 25 years. More specifically, it addresses the question of whether favourable monetary conditions make it more likely that fiscal consolidations, once undertaken, will be continued or successful.

Focusing on fiscal consolidation episodes, it is found that these tend to occur when large budget deficits threaten sustainability and usually when other macroeconomic indicators – inflation, the exchange rate and unemployment – suggest a crisis situation.

After controlling for these factors, the paper finds strong econometric evidence that consolidation efforts are more likely to be pursued, and to succeed, if the monetary policy stance is eased in the initial stages of the episode, thus contributing to offsetting the contractionary impact of fiscal tightening

However, the paper also provides evidence that short and long-term interest rates are more likely to fall during episodes characterised by greater reliance on current expenditure cuts.[adapted from author]

Related content

Document
At the table, off the menu? Assessing the participation of lower-income countries in global tax negotiations
R. Corlin Christensen, M. Hearson, T. Randriamanalina / Institute of Development Studies UK, 2020
For half a century, the most influential international rules and standards for taxing multinational corporations have been formulated by a select group of developed countries, the OECD, with lower-income countries on the outside. Since 2013, this has changed: decision making at the OECD has moved to the ‘Inclusive Framework’ (IF), which today encompasses 137 jurisdictions.
Document
Economic transformation in Vietnam
United Nations University World Institute for Development Economics Research, 2020
During the last three decades Vietnam has undergone a considerable economic transformation. However, little research has considered the role that financial reform has played in the development of small and medium size enterprises (SMEs).
Document
COVID-19 and the African energy sector: Energy insight
W. Shen, S. Ayele / Oxford Policy Management, 2020
As elsewhere in the world, COVID-19 continues to ravage Africa, causing thousands of deaths and an unprecedented health crisis that is damaging to every aspect of the social and economic lives of millions of people.
Document
Lend or suspend? Maximising the impact of multilateral bank financing in the Covid-19 crisis
C. Humphrey, S. Mustapha / Overseas Development Institute, 2020
The Covid-19 pandemic has triggered a collapse in global economic activity that will have lasting economic and social impacts across the world. Recent World Bank estimates suggest that there could be more than 100 million additional people earning less than $1.90 per day as a result of the crisis.
Document
A comparative study of export processing zones in the wake of the Sustainable Development Goals: The cases of Botswana, Kenya, Tanzania, and Zimbabwe
R. Adu-Gyamfi, S.A. Asongu, T.S. Mmusi, H. Wamalwa, M. Mangori / United Nations University World Institute for Development Economics Research, 2020
The objective of this research is to assess the extent to which export processing zones in Botswana, Kenya, Tanzania, and Zimbabwe integrate the Sustainable Development Goals in their implementation and operations. We focused on four Sustainable Development Goals— gender equality, decent work, industry, and climate action. We interviewed four zone authorities, one in each country.

Eldis

Interactions between monetary and fiscal policy: how monetary conditions affect fiscal consolidation