The challenges of balancing monetary policy and fiscal policy


In my introductory statement, I would like to address the relationship between monetary and fiscal policy, as their successful interaction is key to dealing with shocks, such as the economic fallout from the pandemic crisis, and what will follow.

First, the interplay between monetary and fiscal policy has made a comeback in academic research and broader political discourse. It was part and parcel of courses and textbooks when I was a student (well, over 50 years ago). Back then, the questions were more fundamental but still relevant – for example, which policy instruments should be allocated to which policy objective. The instruments assigned have changed over time, the exchange rate regime being an example, and other factors are highlighted, such as the credibility of a policy and its institution.

Recently, the discussion has shifted from consideration of monetary and fiscal policy to strategic substitutes – with contingent state decisions on what to use and when – to thinking about the two policies as strategic additions. With proper design and interaction, each instrument can expand the policy space of the other: More importantly, accommodative monetary policy with low interest rates allows fiscal policy to expand its reach. In turn, fiscal policy action can help the economy recover, easing some of the burden on central banks to get the economy back to potential and inflation back to target.

This renewed interest in policy coordination comes after highlighting the importance of independent central banks and their pursuit of narrow policy goals to be effective and credible. Empirical analysis over the past decades on the effectiveness of fiscal policy relative to monetary policy in dealing with shocks suggests somewhat better outcomes for monetary policy, but little existence of a complementary approach.

This brings me to my second part: has this sub-optimal individual policy approach and joint policy coordination changed with the current crisis? To respect my allotted time, I will focus on the euro area.


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