Cooperation is key in monetary and fiscal policy too

The article examines the interdependence of monetary and fiscal policy in a situation where the ECB is easing monetary policy but fiscal policy is being tightened across Europe.

According to the research literature, monetary policy works best when fiscal policy supports it in the same direction. Tightening monetary policy only lowers prices if fiscal policy is also tightening — and correspondingly, easing monetary policy only stimulates in an environment of expansionary fiscal policy. The mechanism operates through the wealth effect: a fall in interest rates raises household wealth, which increases consumption and inflationary pressures unless fiscal policy counterbalances this.

The central question for Finland is whether tightening fiscal policy will undermine the stimulative effect of easing monetary policy. The differing recovery experiences of the financial market crisis and the coronavirus pandemic support the view that the coordination of policy measures is decisive. (AI translation)

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