This paper analyses how fiscal policy affects monetary policy in emerging
economies. First, it conducts a test for fiscal dominance, and finds that the
evidence points clearly to a regime of fiscal dominance in the case of
Argentina and Brazil during the 1990s and early 2000s, while for the other
countries in the sample the results are mixed. Next, the paper evaluates
whether monetary policy accommodates fiscal policy, by assessing whether fiscal
variables enter significantly in the central bank's reaction function. The
findings indicate that in the emerging markets under consideration the conduct
of monetary policy is not directly affected by changes in real primary
balances. Then, the paper explores another mechanism through which fiscal
policy could affect monetary policy in an emerging economy, by looking at the
impact of fiscal policy on country premium and exchange rates. The empirical
analysis is conducted through an event study, assessing the impact of news
concerning fiscal variables and fiscal policy, on sovereign spread and exchange
rate daily movements in Brazil, during the period surrounding the 2002
macroeconomic crisis. The results show that fiscal events have significantly
influenced sovereign spreads and exchange rates in that period. Furthermore,
fiscal policy actions appear to have contributed to movements in the exchange
rates more than unanticipated monetary policy manoeuvres. The findings also
suggest that, at that time, fiscal policy might have pushed the economy into an
equilibrium in which increases in the policy intervention rate were likely to
be associated with a depreciation, rather than an appreciation of the exchange
rate.
JEL Classification Numbers: E52, E62, E63
Keywords: Monetary Policy, Fiscal Policy, joint analysis of fiscal and monetary
policy