Panel 3: Conducting monetary policy when scal space is limited
95
In any case, there appears to be a Tobin-type “common funnel” also in the
long run. Monetary policy cannot deliver without a sustainable scal policy.
17
However, this was still a world where banks – or non-bank banks (i.e., banks’
functional substitutes) – did not matter. In a number of cases during the global
nancial crisis, however, it was the banking sector and private-debt instability
eroding a presumed scal space extremely rapidly (think of Ireland or Spain).
This has to be accounted for in policymaking going forward. The euro area’s
Macroeconomic Imbalance Procedure (for sure, delicate and complicated) is
a rst attempt at addressing these issues.
Cooperative monetary policy: Is it feasible…
Debt-to-GDP ratios (in cross-country, longitudinal analyses) have a statistically,
but not so much economically, signicant impact on long-term interest rates.
Also, in a number of studies, thresholds with substantial condence bands
show up.
18
In panel analyses, those non-linearities come largely from EMU
member countries, possibly capturing a break-up and ultimately an ination
risk (in a new, devalued currency).
19
Fiscal stress does impact monetary policy.
20
Monetary policy could be forced
to accommodate an inevitable adjustment to a more sustainable position.
Or, it might become subject to the dominance of scal policy. But, it cannot
disentangle itself from this inescapable interdependence.
Accommodative monetary policy, however, might reduce incentives to adjust
budgetary trajectories to a sustainable path. Fiscal policy might stay longer on
an ultimately untenable course, eventually wreaking havoc with the ination
objective. While this moral hazard story is plausible, empirically, monetary
support was a necessary condition of scal consolidation.
With scal policy embarked on an unsustainable path, there is not much
that monetary policy could achieve. Fiscal dominance prevails. In Europe,
in a number of cases, it would be more appropriate to read things through a
lens of nancial dominance. Fiscal policy, despite having the space in at least
17 Woodford (2001, op. cit.) has an epigraph of Karl Brunner’s: “Proposals for a monetary rule require a supplementary
proposal of a scal rule”.
18 See, for example, Cechetti, S., Mohanty, M.S. and Zampoli, F. (2010), “The Future of Public Debt: Prospects and
Implications”, Bank for International Settlements Working Paper No. 300, Basel; and Reinhart, C., Reinhart, V. and
Rogo, K. (2012), “Debt overhangs: Past and Present”, NBER Working Paper No. 18015, Cambridge, MA.
19 Greenlaw, D., Hamilton, J., Hooper, P. and Mishkin, F. (2013), “Crunch Time: Fiscal Crises and the Role of Monetary
Policy”, NBER Working Paper 19297, Cambridge, MA. Employing updated long-term interest-rate and government
debt data for euro area economies, we ran panel xed-eects regressions in the spirit of Greenlaw et al. (2013). Our
results conrm their ndings - they are largely driven by observations from euro area peripheral economies.
20 Greenlaw et al. (2013), op. cit.