Fiscal stance role for ECB monetary policy

Abstract

The objective of this paper is to ascertain the presence of a crucial connection between euro area fiscal stance and ECB monetary policy. To achieve this, we employ the thick modelling approach for the Generalised method of moments to estimate ECB reaction functions with and without a projected fiscal deficit indicator from 2001 until 2022. The results reveal that the actions of the ECB have exhibited desirable effects of stabilising monetary policy, while the projected fiscal deficit was usually not statistically significant in explaining the ECB’s monetary policy stance. However, the sign of fiscal deficit coefficient was positive, implying a counter-cyclical nature of monetary policy with respect to the fiscal stance. This effect has become more evident since 2012, suggesting that the ECB might be taking into account euro area fiscal deficits as providing some indications for potential inflationary risks. Overall, these findings speak against the fiscal dominance or repression regime being prevalent in the euro area.