Monetary policy and sovereign debt: does the ECB take the eurozone’s fiscal risks into account?

A. Hughes Hallett, J. Lewis

Research output: Contribution to journalArticlepeer-review

6 Citations (Scopus)

Abstract

In the standard Taylor rule, fiscal variables are absent and the central bank is assumed to respond in the same way to a given inflation-output gap outlook regardless of the stance of fiscal policy or the outlook for government debt. This paper puts that assumption to the test. Estimating Taylor rules for the ECB using real time data, we find that there is no direct response to the usual instrument of fiscal policy, the cyclical adjusted primary balance. But there is a clear response to the level of debt. Monetary policy tightens by 25 basis points for every 2.5 pp rise in the expected debt to GDP ratio. With ex-post data, we see the opposite: the ECB appears, unfairly since they didn’t have the data, to have acted as if it loosened in periods with a forecasted debt build-up (i.e. in recessions), but tightened in response to past fiscal excesses.
Original languageEnglish
Pages (from-to)499-520
Number of pages22
JournalEmpirica
Volume42
Issue number3
Early online date22 May 2014
DOIs
Publication statusPublished - Aug 2014

Keywords

  • Policy co-ordination
  • Fiscal policy
  • Monetary policy
  • Real time data
  • E63
  • E61

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