The comovement between monetary and fiscal policy instruments during the post-war period in the U.S. |
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Authors: | Jesús Vzquez |
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Institution: | aUniversidad del País Vasco, Spain |
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Abstract: | This paper empirically studies the dynamic relationship between monetary and fiscal policies by analyzing the comovements between the Fed funds rate and the primary deficit/output ratio. Simple economic thinking establishes that a negative correlation between Fed rate and deficit arises whenever the two policy authorities share a common stabilization objective. However, when budget balancing concerns lead to a drastic deficit reduction the Fed may reduce the Fed rate in order to smooth the impact of fiscal policy, which results in a positive correlation between these two policy instruments. The empirical results show (i) a significant negative comovement between Fed rate and deficit and (ii) that deficit and output gap Granger-cause the Fed funds rate during the post-Volcker era, but the opposite is not true. |
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Keywords: | Fed rate Deficit Comovement Switching regimes |
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