En août 2021, l’inflation dans la
zone euro a atteint 3 % en glissement annuel. Un tel niveau n’avait pas
été observé depuis novembre 2011 et dépasse la cible de 2 % que s’est
fixée la BCE. Cette dynamique récente est en partie tirée par le prix du pétrole
mais on observe dans le même temps un rebond de l’inflation sous-jacente, qui
exclut du calcul les indices des prix de l’énergie et du secteur alimentaire. L’inflation
aux États-Unis
renoue également avec des niveaux qui n’avaient pas été observés depuis
plusieurs années, ce qui y alimente le débat sur un potentiel retour du risque
inflationniste. De par leur mandat orienté vers la stabilité des prix, il est
légitime que les banques centrales s’interrogent sur les sources de ce retour
de l’inflation. Dans un document récent en vue de la préparation du Dialogue
monétaire entre le Parlement européen et la BCE, nous discutons cependant
du caractère temporaire plutôt que permanent de cet épisode d’inflation.

By Lucrezia Reichlin, Giovanni Ricco, and Matthieu Tarbé

Abstract

Monetary policy – conventional
or unconventional – has fiscal implications. By affecting interest rates,
inflation and output, it relaxes or tightens the general government budget
constraint. The effect on inflation is then the result of the combined action
of monetary policy and the fiscal response to it via the adjustment of the
primary deficit. In a recent paper, we estimate the fiscal responses to conventional
and unconventional monetary policy in the four largest countries of the euro
area. We find a positive primary deficit response to conventional short-term
interest rate easing. In contrast to this fiscal-monetary coordination in the
conventional case, fiscal responses to unconventional monetary policy easing are
muted. They generate crosswinds, which is consistent with the more modest
impact of unconventional monetary policy on inflation.

Inflation
in the euro area as a joint fiscal-monetary phenomenon

The topic of
coordination between monetary and fiscal policy has become the focus of policy
discussion in recent years (Draghi, 2014, Lagarde, 2020, Schnabel, 2021). One
reason is that there is limited space for traditional monetary policy based on
steering the short-term interest rate when the latter is at or close to the
effective lower bound (ELB). Many recent papers have advocated mechanisms to
implement a coherent a monetary-fiscal policy mix (see for example the policy
report by Barsch et al 2021).

Empirically,
there is limited knowledge about how the combination of monetary and fiscal
policy affects inflation. This is a complex topic since there are multiple
channels of interaction. Monetary policy, by affecting interest rates, output
and inflation has an impact on the government’s budget constraint. The response
of fiscal authorities via the adjustment of the primary deficit depends on the
fiscal framework or their stabilization objectives. The effect on inflation
depends on the combined effects of fiscal and monetary actions as these affect
the adjustment which is required to satisfy the intertemporal budget constraint
of the consolidated government sector (central bank and governments). This is the
consequence of the constraint being a binding identity which depends on
inflation, returns on government debt and primary surpluses.

In the
governance of the Euro Area (EA), the central bank is an independent
institution and the treaties have delegated to it the responsibility for price
stability. As a consequence, the budget constraints of the central bank and
governments must be thought as separate ex-ante. However – ex-post – what
matters to understand the dynamics of inflation is the consolidated budget
constraint of the central bank and the nineteen fiscal authorities. Therefore,
if we want to understand the causes of the under-shooting of the inflation
target since 2013 in the European Monetary Union (EMU), we need to consider how
primary deficits and returns have responded to monetary policy.

In a recent paper (Reichlin, Ricco, Tarbé,
2021) we estimated empirically the response of fiscal variables, inflation and
the market value of government debt to monetary policy changes affecting the short-term
rate (traditional policy) or long-term rates (forward guidance or quantitative
easing). Beside estimating VAR-based impulse response functions, we used the
intertemporal budget constraint identity to obtain a decomposition of unexpected
inflation (conditional on monetary policy) into several components: the primary
deficit, returns on the market value of government debt, and output growth. We
modelled this relationship using euro area aggregate data and a newly
constructed dataset for France, Germany, Italy and Spain.

Our framework is inspired by Hall and Sargent
(1997) and Cochrane (2019, 2020). Common to their approach is to start from the
general government intertemporal budget constraint as an equilibrium identity
linking the market value of the debt to future discounted primary surpluses.

From that budget constraint, one can obtain a linearized
identity that, in words, is of the following shape:

where each term is to be thought of as an
unexpected change.

The intuition is that an unexpected contemporaneous
increase in inflation – if not matched by a movement in contemporaneous returns
– has to correspond to either a decline in the (cumulated) surplus to GDP
ratios, or a decline in cumulated GDP growth, or a rise in the discount rates[1].
These adjustments in the aggregate can happen as a combination of symmetric or
asymmetric changes at the country level.

Since this identity involves bond returns,
inflation and fiscal variables, it can be used to learn about the
fiscal-monetary adjustment dynamics in an otherwise unrestricted empirical model.

To apply this framework to the euro area we
need to extend it to the case of a single central bank and multiple fiscal
authorities.

We focus on a stylised description of the EMU
in which each country can issue debt and hence faces different market rates
(and returns). Inflation at the euro area level is determined by the aggregate
fiscal and monetary stance, and the aggregate fiscal stance is the sum of the
fiscal positions of individual states that may or may not balance their budgets
independently, and take inflation as given. Such a description is open to
nuances such as divergences in the national inflation rates in the medium-run,
and fiscal transfers across countries to help balancing out national fiscal
imbalances. Whether such mechanisms operate or not is an entirely empirical
matter.

Conventional
monetary policy and the fiscal stance

We identify the shocks in the model using a
combination of sign restrictions, as in Uhlig (2005), and the recently proposed
narrative sign restrictions of Antolin-Diaz and Rubio-Ramirez (2018). In
addition to traditional sign restrictions, we constrain an expansionary
conventional monetary policy shock (MP) to have a negative impact on the short-
and long-term interest rates, a positive impact on output, and a positive
impact on inflation and inflation expectations for the first three quarters (inflation
moving by a larger amount). We separately identify the MP and unconventional
monetary policy shocks (UMP) based on their differential impacts on the yield
curve. The MP shock is assumed to move short term interest rates by a larger
amount than long term rates, leading to a steepening of the yield curve. The
UMP shock has the opposite effect on the slope. We also assume that monetary
policy shocks are neutral and do not affect real GDP, in the long-run.[2]

A first set of results pertains to
conventional monetary policy (Figure 1). GDP and inflation respond as expected:
there is a hump-shaped impact on GDP, peaking at about 0.1% in the second year,
and an immediate impact on inflation and inflation expectations. In line with
the transitory nature of the shock, the impact on long-term yields is both
small in magnitude and short lived.

What is more interesting for our discussion are
the responses of the fiscal variables. For the aggregate we estimate an
immediate decline in the surplus-to-EA-GDP ratio which, as shown in Figure 1,
is driven by France, Germany and Italy, whereas Spain responds with a surplus. The
value of debt-to-EA-GDP ratio falls for all countries in the first two years, although
there is a high degree of uncertainty in these estimates.

Figure 1 – Impulse response functions to a one standard deviation conventional monetary policy shock (easing) in the euro area

Note: The shock is a small cut in the short-term
interest rate, of about 10 basis points. The impulse response of real GDP is
reported in level, i.e. as percentage deviation from the steady state. All
other impulse responses are reported as annualized percentage-point deviations
from the steady state. For details on the quarterly data construction and which
variables enter the estimation, see appendix B of Reichlin et al. (2021). Inflation
and interest rates are in % (annualized). Slope is the German long-term
interest rate minus the euro area short-term interest rate. Returns are nominal
returns in % (annualized) on the portfolio of government debt, inferred from debt
and surplus. Spreads are country long-term interest rates minus the German
long-term interest rate. Debts are 400 times the logarithm of the following
ratio: country debt over quarterly euro area GDP. Surpluses denote 400 times country
primary surplus over quarterly euro area GDP, scaled by country debt over quarterly
euro area GDP at steady state.

The response of the return on government debt
is ambiguous since it is driven by both short- and long-term interest rate
movements, while sovereign spreads do not appear to react significantly to the
conventional MP shock, indicating a symmetric transmission across the euro area.

Long-term results (not shown here) point to a
decomposition of unexpected inflation which is split by fiscal policy easing in
the same direction as monetary policy and a relatively muted response of
returns on the market value of the debt. As we will see in the next section,
this contrasts with the response to unconventional monetary policy. These
results have to be understood as indicative, since long-run estimates are necessarily
imprecise due to the uncertainty in the assumptions on the level of the steady
states.[3]

To summarise, we report evidence of
fiscal-monetary coordination conditional on a conventional monetary policy
easing: in response to the decline in interest rates, the fiscal authorities
allow the surplus-to-EA-GDP ratio to decline. The overall impact of the policy
is an increase in output, an increase in inflation, and an insignificant
decline in the debt-to-EA-GDP ratio.

This is not the case for an unconventional
monetary policy easing driving long-term interest rates down.

Unconventional
monetary policy and crosswinds

A second set of results is reported in Figure
2, for unconventional monetary policy. We observe a small positive reaction of
output and a sizable response of inflation on impact, yet both effects are less
persistent than in the case of a conventional shock. The effect on the
surpluses is negligible and not significant. While the value of the debt
increases on impact for some countries, the response is not significant beyond
the first period. This is associated with an unambiguous response in the
returns on government debt, which explains this increase in the market value of
the debt in Germany and France.

Figure 2 – Impulse response functions to a one standard deviation unconventional monetary policy shock (easing) in the euro area

Note: A one standard deviation shock corresponds to a 10 basis points decline in the long-term yield. The impulse response of real GDP is reported in level, i.e. as percentage deviation from the steady state. All other impulse responses are reported as annualized percentage-point deviations from the steady state. For details on the quarterly data construction and which variables enter the estimation, see appendix B of Reichlin et al (2021). Inflation and interest rates are in % (annualized). Slope is the German long-term interest rate minus the euro area short-term interest rate. Returns are nominal returns in % (annualized) on the portfolio of government debt, inferred from debt and surplus. Spreads are country long-term interest rates minus the German long-term interest rate. Debts are 400 times the logarithm of the following ratio: country debt over quarterly euro area GDP. Surpluses denote 400 times country primary surplus over quarterly euro area GDP, scaled by country debt over quarterly euro area GDP at steady state.

Let us now show results for the inflation
decomposition in the long-run:

Unexpected inflation decomposition in terms of changes to returns
and future cumulated changes to growth, surplus, returns and inflation. The
country columns display numbers weighted by country shares. For details on the
quarterly data construction and which variables enter the estimation, see
appendix B of Reichlin et al (2021). Inflation is in % (annualized). Returns
are nominal returns in % (annualized) on the portfolio of government debt,
inferred from debt and surplus. Surpluses denote 400 times country primary
surplus over quarterly euro area GDP, scaled by country debt over quarterly euro
area GDP at steady state.

The unexpected inflation decomposition
reported in the table shows that the 10 basis points (bps) decline in the
long-term rate due to the unconventional monetary policy shock corresponds to a
large adjustment in the nominal returns, which jump by 95 bps in the short run and
then contract by 69 bps in the future. Overall inflation movements are muted,
about a half of what is seen in the case of conventional monetary policy. We
have a jump by 9 bps in the short run, and then a cumulated decline by 1 bps in
the future. Thus, the real discount rate term is -68 bps. While in the case of
conventional monetary policy we have seen a cumulated deficit in the long-run, here
we have a cumulated primary surplus to GDP ratio response of 14 bps, generating
crosswinds in the aggregate. This long-run finding is mainly to be attributed
to Germany.

The muted fiscal response conditional on an UMP
shock is telling us that when that policy was active, i.e. since the 2008
crisis (first via targeted loans, then via forward guidance and asset
purchases), fiscal authorities did not use the fiscal space afforded by the decrease
in long-term rates. The response of the primary surplus to a monetary policy
easing is insignificant in the short-run and overall positive in the long-run,
unlike in the case of conventional policy (negative both at business cycle
frequency and in the long-run).

These results come with two warnings. First,
as we have seen, estimates are quite imprecise. Second, long run results are also
sensitive to assumptions on the steady state, as already commented. This is a
problem hard to address given the short sample and the evolving policy
landscape.

To sum up, in contrast with the conventional
monetary policy case, the response of inflation and output is muted, and there
is no fiscal expansion.

Conclusions

In the euro area the empirical fiscal-monetary
mix appears to vary depending on the conventional (i.e. affecting the short-term
interest rate) or unconventional (i.e. shifting the long end of the yield curve)
nature of the monetary policy shock.

Key in this difference are two factors: (i)
the movement of the returns on the value of the debt, which depends on the
change in yields at the relevant maturity, and (ii) the response of the primary
surplus, which depends on fiscal policy.

Nonstandard monetary policy has a much larger
effect on returns since, given the average debt maturity, long-term yield
changes have a higher impact on returns than changes in the short-rate. The
long-run price level is lower than in the conventional policy case, while the
primary surplus response is muted and slightly positive in the long-run.

The interpretation of this result is as
follows: when unconventional monetary policy was implemented – post financial
crisis – the combination of high legacy debt and fiscal rules constrained the fiscal
response, determining a situation in which the monetary and fiscal authorities
worked against one another.

Paradoxically, when the economy was at the ELB,
in a situation in which fiscal policy is more powerful than monetary policy,
the responsibility for stabilization fell on the shoulders of monetary policy
alone.

References

Antolin-Diaz, Juan and Juan Francisco Rubio-Ramirez, “Narrative Sign
Restrictions for SVARs, » American Economic Review, October 2018, 108 (10),
2802-29.

Bartsch, Elga, Agnès Bénassy-Quéré, Giancarlo Corsetti, Xavier Debrun “It’s
All in the Mix: How Monetary and. Fiscal Policies Can Work or Fail Together”.
Geneva Reports on the World Economy 23, 2021.

Cochrane, John H, “The fiscal roots of inflation, » Technical Report,
National Bureau of Economic Research 2019.

Cochrane, John H., “The Fiscal Theory of the Price Level”, Unpublished,
2020.

Draghi, Mario, “Unemployment in the euro area, » Speech by Mario
Draghi, President of the ECB, Annual central bank symposium in Jackson Hole,
European Central Bank 2014.

Hall, George J. and Thomas J. Sargent, “Interest rate risk and other
determinants of post-WWII US government debt/GDP dynamics, » American
Economic Journal: Macroeconomics, 2011, 3 (3), 192-214.

Lagarde, Christine, “Monetary policy in a pandemic emergency, »
Keynote speech by Christine Lagarde, President of the ECB, at the ECB Forum on
Central Banking, European Central Bank 2020.

Reichlin, Lucrezia and Ricco, Giovanni and Tarbé, Matthieu,
Monetary-Fiscal Crosswinds in the European Monetary Union (May 1, 2021). CEPR
Discussion Paper No. DP16138.

Schnabel, Isabel, “Unconventional fiscal and monetary policy at the zero
lower bound, » Keynote speech by Isabel Schnabel, Member of the Executive
Board of the ECB, at the Third Annual Conference organised by the European
Fiscal Board on “High Debt, Low Rates and Tail Events: Rules-Based Fiscal
Frameworks under Stress », European Central Bank 2021.

Uhlig, Harald, “What are the effects of monetary policy on output?
Results from an agnostic identification procedure, » Journal of Monetary
Economics, March 2005, 52 (2), 381-419.

[1] Cochrane (2019) then further decomposes the contemporaneous nominal
return term, between a future inflation term and a future real discount rate
term, by assuming a geometric maturity structure. Unexpected
inflation has to correspond to a decline in expected
future surpluses, or a rise in their discount rates.

[2] We complement the restrictions on impulse responses with narrative
sign restrictions, following Antolin-Diaz and Rubio-Ramirez (2018). In
particular we assume that: (i) a contractionary (negative) conventional
monetary policy shock happened on the third quarter of 2008 and the first
quarter of 2011, and it was the single largest contributor to the unexpected
movement in the short-term interest rate during those two periods; (ii) an
expansionary (positive) unconventional monetary policy shock took place on the
first quarter of 2015, and it was the single largest contributor to the
unexpected movement in the term spread between the German long-term interest
rate and the short-term interest rate during that period.

[3] Our steady state assumptions are consistent with the
debt-to-Euro-Area-GDP ratios of each of the countries being equal to their
historical average, and the primary surpluses being zero in the long run. We
also impose that the steady state inflation rate is equal to 1.9%, `below but
close to 2%’ as specified by the ECB’s inflation objective. For real GDP
growth, we fix the steady state at 1.5%, close to the sample average.
Consistent with our choice for the steady state surplus, we fix the
steady-state returns on the government debt portfolio at

.

Finally,
the short-term real interest rate is assumed to be 1% in steady state, the
spread between the long- and short-term interest rates to be 100 basis points,
the sovereign spread to be 50 basis points for France, and 100 basis points for
Italy and Spain.

Comme chaque année, un peu avant
le printemps, l’OFCE publie dans la collection « Repères » des
Editions La Découverte un ouvrage synthétique sur l’état de l’économie
européenne et sur les enjeux de l’année à venir, L’économie
européenne 2020. Il faut bien admettre que lors de la préparation de l’ouvrage,
dont le dernier chapitre a été achevé au tout début de l’année 2020, nous n’avions
pas anticipé que l’épidémie liée au coronavirus en Chine engendrerait la crise
sanitaire et économique globale dont nous subissons les effets depuis quelques
semaines. Aussi l’ouvrage ne répond-il pas à l’actualité essentielle du moment.
Il livre cependant quelques pistes de réflexion qui s’avéreront sans doute utiles
lorsque la phase aiguë de la crise sanitaire aura été dépassée. Ces pistes de
réflexion concernent l’impulsion politique européenne des derniers mois de
l’année 2019 et les ambitions de la nouvelle Commission européenne, les
perceptions des Européens à l’égard de l’Union européenne et les outils
macroéconomiques à mobiliser pour contrecarrer un ralentissement économique ou
une fragilisation du secteur bancaire.

En septembre 2019, la Banque centrale européenne (BCE) annonçait une relance de ses politiques « non conventionnelles », incluant, en sus de l’assouplissement quantitatif (quantitative easing) et des opérations ciblées de refinancement à long terme (targeted long-term refinancing operations, TLTRO), une baisse du taux des facilités de dépôts[i] avec une tranche de monnaie de réserve exonérée des taux négatifs de manière à limiter le coût des réserves pour les banques. Ce nouveau round de politiques accommodantes s’imposait en raison du contexte macroéconomique, marqué par un ralentissement de l’activité en zone euro et un décrochage de l’inflation.