What empirical issues arise with monetary-fiscal policy interactions?

Following on from the previous presentation, these notes discuss empirical issues that arise with monetary-fiscal policy interactions: observational equivalence; two problems with surplus-debt regressions that arise from the existence of the forward-looking bond-valuation condition and confronting fiscal data.

In econometrics, two structures are observationally equivalent if they imply the same probability distribution of data. The two regimes discussed n the previous presentation can be observationally equivalent if they produce equilibrium data with the same covariance generating process. After exploring how this can be addressed, the presentation shows that exogenous shocks to Monetary and Fiscal Policy have starkly different impacts in the two regimes.

The two problems with surplus-debt regressions that arise from the existence of the forward-looking bond-valuation condition are firstly, that a primary surplus depends on the level of debt from the previous year ie. the accumulation of past gross deficits. This view reflects the “backward” interpretation of debt. Secondly, in monetary policy if the price of bonds depends on the expected surpluses, then the debt-GDP ratio depends on future surpluses. Since single-equation estimates of γ (the term that determines the sustainability of the policy) cannot control for these features of the general equilibrium, regressions are most likely to be unreliable in cases where surpluses do not respond to debt.

Analysing fiscal data is difficult. Deficits are usually followed by surpluses and surpluses are not auto-regressive. This presentation is aimed at those who are not only very passionate about the topic, but have a technical understanding of policy interaction. Take a look to learn about the identified areas of future research.