ECB Working Paper: Combo of Monetary and Fiscal Accommodation Has Chance to Work
6 December 2021
By David Barwick – FRANKFURT (Econostream) – A European Central Bank working paper published Monday said that simultaneously applying expansive monetary and fiscal policies could substantially improve growth and boost inflation without necessarily leading to unsustainable debt.
The working paper - the views presented in which the ECB said ‘do not necessarily reflect’ those of the ECB – looked at the macroeconomic impact of different euro area fiscal and monetary policies and in particular tried to determine what policy mixes would favour a strong post-pandemic recovery.
The paper found that ‘the combination of expansionary-for-longer fiscal policy and low-for-longer monetary policy has a chance to significantly improve macroeconomic prospects’, where fiscal support would be left in place even after the output gap had been closed and interest rates were left low beyond the conventional inflection point.
Such a policy mix could allow the euro area to recoup about half of all pandemic-related output losses while getting inflation near to the ECB’s price stability target, the paper reported.
Despite the additional debt incurred to finance such fiscal accommodation, debt-to-GDP would under most scenarios remain around 100%, the paper said.
The analysis supported the idea of complementarity between fiscal and monetary policy, with the former exerting a greater inflation and growth impact when monetary policy is patient than when monetary policy is tightened according to standard thinking.
‘In the same vein, the ability of monetary policy to positively influence macroeconomic conditions is greater when fiscal policy is expansionary-for-longer rather than when fiscal policy behaves as it did in the past’, the authors said.
Moreover, according to the paper, ‘[f]iscal policy alleviates the ELB constraint faced by monetary policy, thereby empowering the central bank’, while ‘monetary policy limits the cost of fiscal policy by preserving favourable financing conditions, hence it positively influences the fiscal space.’
The authors said this amounted to ‘a strong case for coordination between the two policies at the current juncture.’