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Policy mix and debt sustainability: evidence from fiscal policy rules

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Abstract

This paper characterizes rules-based fiscal policy setting for G-3 and large EMS countries. We set up a simple fiscal policy rule and then infer on the policymakers’ reaction coefficients by testing with GMM. Our results qualify existing evidence on systematic fiscal policy in two respects. First, fiscal policy usually stabilizes public debt; and there is indeed substantial interaction between fiscal and monetary policies via the policy mix or the debt channel. Second, sustainability is achieved with a “stop–go” cycle of consolidation. Unless debt ratios are high, consolidation does not come at the cost of less cyclical stabilization.

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Acknowledgements

This paper is based on my doctoral research on “Fiscal and Monetary Policy Interaction: an empirical analysis”. I would like to thank three anonymous referees, and my supervisors Anindya Banerjee and Michael Artis for helpful suggestions. Further comments by Florin Bilbiie, Andrew Hughes Hallett, Alessandro Missale, Albrecht Ritschl and by participants at the CESifo conference on “Sustainability of Public Debt” also provided many insights. Any remaining errors are mine. Research is supported by the “Campilli-Formentini” grant of the European Investment Bank.

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  1. Department of Economics, European University Institute, Villa San Paolo, Via della Piazzuola, 43, I-50133, Firenze, Italy

    Peter Claeys

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  1. Peter Claeys
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Correspondence to Peter Claeys.

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Claeys, P. Policy mix and debt sustainability: evidence from fiscal policy rules. Empirica 33, 89–112 (2006). https://doi.org/10.1007/s10663-006-9009-9

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